Individual income tax, gift tax, estate tax, rules and bulletins ...

State of North Carolina
INDIVIDUAL INCOME TAX
GIFT TAX
ESTATE TAX
RULES AND BULLETINS
TAXABLE YEARS
2005 and 2006
Issued by:
Personal Taxes Division
Tax Administration
North Carolina Department of Revenue
501 North Wilmington Street
Raleigh, North Carolina 27604
PREFACE
This publication was prepared for the purpose of presenting the
administrative interpretation and application of North Carolina income
tax laws relating to individuals, partnerships, estates, trusts, and gifts in
effect at the time of publication for income years beginning on and after
January 1, 2005. This publication does not cover all provisions of the
law.
Taxpayers are cautioned that this publication is intended merely as a
guide and that consideration must be given to all the facts and
circumstances in applying these bulletins to particular situations.
Taxpayers using this publication should be aware that additional changes
may result from legislative action, court decisions, and rules adopted or
amended under the Administrative Procedure Act, Chapter 150B of the
General Statutes. In no case should these bulletins be relied upon for
years other than the taxable years 2005 and 2006.
Revised December 2005
TAXPAYERS’ BILL OF RIGHTS
The North Carolina Taxpayers’ Bill of Rights explains
your rights as a taxpayer.
This Bill of Rights is designed to provide you with information about:
• Protection of Privacy
• Examination of Returns
• Hearing & Appeals Process
• Revenue Collection Process
• Refund of Overpaid Tax
• Penalties & Interest
As a taxpayer, you are always entitled to fair, professional, prompt and courteous service. Our goal is to
apply the tax laws consistently and fairly so that your rights are protected and to see that you pay only your
fair share of North Carolina tax.
Protection of Privacy — It is your right to have information about your tax history, financial situation,
assessments or reviews kept in strict confidence. Any return information, correspondence, or departmental
discussions concerning your tax situation will be completely confidential. Employees or former employees
who violate this confidentiality are subject to criminal prosecution which may result in dismissal plus fines.
Examinations — The Department of Revenue routinely examines returns to ensure that taxpayers comply with
tax statutes. If we examine your return, we may ask you to provide information to verify figures on your return.
Examinations are done by mail or through personal interviews with auditors. You have the right to ask that
the examination be held at a time and place convenient for you and the auditor.
You are entitled to a fair examination and an explanation of any changes we propose to your return. Exami -
nations do not necessarily mean additional taxes. Your case could be closed without any changes or you
could receive a refund.
Representation — During any examination, review, or hearing, you may have an attorney, accountant, or
designated agent present. You can authorize another person to represent you if you execute a written power
of attorney. If you wish, the Department will suspend the proceedings at any time to permit you to consult with
your authorized representative.
You may make an audio recording of the proceedings at your own expense with your own equipment. The Department
may also audio record the proceedings. If we do so, you can get a copy of the transcript for a nominal charge.
Appeals — You have the right to appeal the actions of the Department of Revenue if you do not agree with
a proposed assessment or reduced refund. To appeal a tax notice, you must file a written request, either for a
hearing or for a written statement of the information on which the notice is based. The request must be mailed
to the Department within 30 days from the date the notice was mailed to you. If you request a written statement
about your notice, you will receive it within 45 days. You then have 30 days from the date the statement was
mailed to file a written request for a hearing.
Hearings — The Secretary of Revenue will notify you of the time and place of an administrative tax hearing
within 60 days after you request one and at least 10 days before the date set for the hearing. The hearing will
be scheduled within 90 days of your request or at a later date mutually agreed upon by you and the Department.
The date set for the hearing may be postponed once at your request and once at the Secretary’s request.
All parties attending a hearing may present information and ask questions. Written decisions are mailed
to taxpayers following hearings.
If you disagree with the findings of your hearing, you may:
• Petition the Tax Review Board for administrative review of the decision, or
• Pay the tax and sue to recover the amount paid.
To have an administrative review, you must file a notice of intent to petition for review with the Tax Review
Board within 30 days of the hearing decision.
After filing the “ notice of intent”, you must file a written statement or “ petition” within 90 days of the
hearing decision explaining your objections to the decision.
If the Tax Review Board upholds the decision of the Secretary of Revenue, you have the right to appeal to
the Superior court. ( The appeal information is a general description of your appeals rights and does not
cover all situations)
Collections — If the proposed assessment is upheld upon the conclusion of the appeals process, the
assessment becomes final and collectible.
You are responsible for the full amount of tax you owe, but we will not take action to collect from you until you
have had an opportunity to pay voluntarily. It is important that you respond promptly if we contact you for
payment. If you do not pay the amount of tax, penalty, and interest you owe within 90 days after a final notice of
assessment was mailed to you, the law requires the Department to add a 20% collection assistance fee to your debt.
The fee does not apply if you enter into an installment payment agreement with the Department before the fee is
imposed.
If you do not pay, the Department of Revenue may garnish your wages, bank account or other funds, issue
a tax warrant to your sheriff, or record a certificate of tax liability against you.
If we believe that you owe tax and collecting that tax is in jeopardy, the Department can immediately assess
and collect the tax. You are entitled to an administrative tax hearing on the jeopardy assessment. If you
disagree with the findings of the hearing, you have the right to bring civil action in Superior Court.
Refund of Overpaid Tax — If you believe you have overpaid your taxes, you have the right to file a claim for refund.
Generally, you can apply for a refund of tax paid at any time within three years after the due date of the return
or within six months of paying the tax, whichever is later.
If we select your claim for examination, you have the same rights you would have during an examination
of your return.
Penalties & Interest — By law, the Department of Revenue is required to assess penalties for the following.
• Late Filing of Returns • Fraud
• Late Payment of Tax • Bad Checks/ EFT Payments
• Negligence
You have the right to request that penalties be waived. The Department waives penalties in accordance
with its Penalty Waiver Policy.
Interest accrues on unpaid taxes from the date the tax was due until the date it is paid. Interest is also
applicable to the underpayment of estimated income tax. The law does not permit the Department to waive
interest which accrues on unpaid taxes.
CONTENTS
I. Filing Individual Income Tax Returns ........................ 1
II. Filing Requirements ................................................. 6
III. Computation of Taxable Income ............................. 10
IV. Bailey Settlement ................................................... 23
V. Net Operating Losses ............................................. 28
VI. Nonresidents and Part - year Residents .................... 31
VII. S Corporations ....................................................... 37
VIII. Estates and Trusts ................................................... 44
IX. Partnerships ........................................................... 47
X. Taxable Status of Distributions from
Regulated Investment Companies ....................... 52
XI. Tax Credits ............................................................. 54
XII. Statute of Limitations and Federal Changes ............ 68
XIII. Penalties, Interest, and Required Filing of
Information Returns ............................................ 72
XIV. Miscellaneous Rules .............................................. 74
XV. Withholding from Pensions, Annuities
and Deferred Compensation ................................... 78
XVI. Withholding from Nonresidents for Certain
Personal Services ............................................... 82
XVII. Withholding of Income Tax..................................... 88
XVIII. Reporting and Paying Tax Withheld ........................ 96
XlX. Estimated Income Tax ............................................. 99
XX. Interest on Underpayment of
Estimated Income Tax ....................................... 101
XXI. Gift Tax ................................................................ 104
XXII. Estate Tax ............................................................. 109
Index..................................................................... 112
IMPORTANT TOLL FREE TELEPHONE NUMBERS
TAXPAYER ASSISTANCE AND FORMS 1- 877- 252- 3052
AUTOMATED REFUND INQUIRY LINE 1- 877- 252- 4052
( Available 24 hours a
day, 7 days a week)
FREQUENTLY ASKED QUESTIONS 1- 877- 252- 3052
INTERNAL REVENUE SERVICE 1- 800- 829- 1040
( Toll free within
North Carolina)
TAX FRAUD HOTLINE 1- 800- 232- 4939
( 733 - 6354 in Wake
County) Toll free from
8: 00 a. m. to 5: 00
p. m., Monday through
Friday, except
holidays.)
DEPARTMENT OF REVENUE WEBSITE
www. dornc. com
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I. Subject: Filing Individual Income Tax Returns
1. Forms
The individual income tax return, Form D - 400, is available from the
Department of Revenue in Raleigh or from any of the Department’s
Service Centers located throughout the State. The return and other related
schedules are also avaliable from the Department’s website at
www. dornc. com.
2. Electronic Tax Filing
The North Carolina Department of Revenue participates in the Federal/
State e- file program. This program allows residents, nonresidents, and
part - year residents to file their federal and State individual income tax
returns in a single electronic transmission or file their State return
separately. E- file is the fastest, safest, and most accurate way to file
income tax returns. Taxpayers who e- file can have their refunds direct
deposited into a checking or savings account. E- file is offered by a
rapidly growing number of tax practitioners. A list of tax practitioners
that offer electronic filing is on the Department’s website,
www. dornc. com. The State return can be a refund, zero tax due, or
balance due return.
To participate in the Federal/ State e- file Program, a tax practitioner
must complete IRS Form 8633, Application to Participate in the E- file
Program, and submit it to the IRS. The practitioner must have been
accepted into the program and received an Electronic Filing Identification
Number ( EFIN) in order to participate in State e- file. The Department
will have access to the Federal Applicant Database that enables the
Department to reference pertinent information regarding the tax
practitioner. The tax practitioner must use computer software that has
been approved by the IRS and the Department of Revenue for filing.
The Department of Revenue maintains a list of approved software
developers on its website.
The Department of Revenue also participates in the Federal/ State
Online Filing Program. A taxpayer with a personal computer and modem
can file their federal and State returns in one transmission or the State
return separately. A taxpayer must use approved online software to e- file
the federal and State returns. A list of approved online software products
is on the Department’s website.
3. Items Requiring Special Attention
The individual taxpayer or his agent should give special attention to the
following items when preparing an individual income tax return:
a. The Form D - 400 for the proper year should be used. For example,
a 2005 form should be used by a taxpayer whose calendar year
ends December 31, 2005. A taxpayer filing on a fiscal year basis
whose fiscal year begins in 2005 should also use a 2005 form.
2
b. The first name, middle initial, last name and the current mailing
address of the taxpayer ( taxpayers; if joint) should be printed in
the applicable boxes on the tax return. Do not use the name or
address shown on a wage and tax statement if incorrect. Enter
the social security number( s) in the applicable boxes.
c. When filing an income tax return for an unmarried individual who died
during the taxable year, enter the date of death in the applicable box.
d. When filing a separate return of a decedent who was married at
the time of death, enter the date of death in the applicable box and
enter the address of the surviving spouse or personal representative.
e. The taxpayer is required to furnish his social security number with
the return. This number is necessary to verify the identity of the
taxpayer, since the Department identifies taxpayers and credits
refunds and payments by social security number.
Separate returns of spouses are often interrelated whether they
are living together or apart; therefore, the taxpayer is asked to
furnish the name and social security number of the spouse if they
file on separate forms, but not if they are divorced. This information
can save time, correspondence, and difficulty for the taxpayer
and the Department.
f. The same filing status claimed on the federal income tax return
must also be claimed on the North Carolina income tax return.
However, if either the taxpayer or the taxpayer’s spouse is a
nonresident and had no North Carolina taxable income for the taxable
year, the filing status Married Filing Separately must be claimed.
g. The tax must be computed accurately and any penalty and interest
prescribed by statute should be included on the return.
h. If additional tax is due on the income tax return, it can be paid by
check or money order with the return, or it can be paid online by
bank draft or credit or debit card using Visa or MasterCard. Note:
The Department will not accept a check, money order, or cashier’s
check unless it is drawn on a U. S. ( domestic) bank and the funds
are payable in U. S. dollars.
i. If an individual has moved into or out of North Carolina during the
tax year or is a nonresident with income from sources within North
Carolina, the section on page 4 of Form D - 400, “ Computation of
North Carolina Taxable Income for Part - Year Residents and
Nonresidents” must be completed. Credit for tax paid to another
state is not allowed to an individual moving into or out of this state
unless the individual has income derived from and taxed by another
state or country while a resident of this State. ( See Credit for Tax
Paid to Another State or Country on page 54.)
j. If a tax credit is claimed for tax paid to another state or country,
there must be attached to the return a true copy of the return filed
3
with the other state or country and a cancelled check, receipt, or
other proof of payment of tax.
k. Every return must be signed and dated by the taxpayer or the
taxpayer’s authorized agent, and joint returns should be signed and dated
by both spouses. A refund may be delayed by an unsigned return.
l. Where tax has been withheld, the original or copy of the original
State wage and tax statement that was received from an employer
must be attached to the return. Wage and tax statements or 1099
statements generated by tax software programs cannot be used
to verify North Carolina tax withheld.
m. Any additional information that will assist in the processing and
auditing of a return should be attached to the return.
n. Anyone who is paid to prepare a return must sign and date the return
in the space provided. When more than one person prepares a return,
the preparer with primary responsibility for the overall accuracy of
the return must sign as the preparer. The preparer must manually sign
and date the prepared return. Preparers may use the practitioner ID
number ( PTIN) in lieu of their social security number. Preparers
should also include their phone numbers in the space provided.
4. Substitute Returns
Any facsimile or substitute form must be approved by the Department
of Revenue prior to its use. The guidelines for producing substitute
forms are available in the publication, “ Requirements for the Approval
of Substitute Tax Forms.” The publication is available on the
Department’s Website, or it can be obtained by contacting the
Department’s forms coordinator. If you use computer generated returns,
the software company is responsible for requesting and receiving an
assigned barcode. The Department publishes a list of software developers
who have received approval on it’s website. Photocopies of the return
are not acceptable. Returns that cannot be processed by the
Department’s imaging and scanning equipment may be returned to the
taxpayer with instructions to refile on an acceptable form.
5. Federal Forms
Taxpayers must include a copy of their federal return with the North
Carolina return unless their federal return reflects a North Carolina address.
6. Extensions
If an income tax return cannot be filed by the due date, an individual
may apply for an automatic six - month extension of time to file the return.
To receive the extension, an individual must file Form D - 410, Application
for Extension for Filing Individual Income Tax Return, by the original
due date of the return. A copy of the individual’s federal extension is
not acceptable. Partnerships, estates, or trusts must file Form D - 410P,
Application for Extension for Filing Partnership, Estate, or Trust Tax
Return, to apply for an extension of time to file a return.
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Although a taxpayer is not required to send a payment of the tax
estimated to be due, it will benefit the taxpayer to pay as much as possible
with the extension request. An extension of time for filing the return
does not extend the time for paying the tax. If the tax due is not paid by
the original due date, interest will be due on the unpaid amount. The 10
percent late payment penalty will not be due if the taxpayer pays at least
90 percent of the tax liability through withholding, estimated tax payments,
or with Form D - 410 by the original due date.
A late filing penalty may be assessed if the return is filed after the due
date ( including extensions). The penalty is 5 percent per month ($ 5
minimum; 25 percent maximum) on the remaining tax due.
If the application for extension is not filed by the original due date of
the return, the taxpayer is subject to both a late filing penalty and a late
payment penalty. The penalties will also apply if the extension is not valid.
An application for extension is considered invalid if the amount entered on
the extension form as the tax expected to be due is not properly estimated.
In determining whether the amount reflected as tax due on the application is
properly estimated, all facts and circumstances, including the amount of tax
due in prior years, whether substantial underpayments have been made in
other years, and whether an individual made a bona fide and reasonable
attempt to locate, gather, and consult information, must be considered.
Individuals living outside the United States or Puerto Rico ( including
military personnel) are granted an automatic 4 - month extension for filing
a North Carolina income tax return if they attach a statement to their
return to explain that they were out of the country on the due date of the
return. Form D - 410 does not have to be filed. The time for payment of
the tax is also extended; however, interest is due on any unpaid tax from
the original due date of the return until the tax is paid. If an individual is
unable to file the return within the automatic 4 - month extension period,
an additional 2 - month extension may be obtained by filing Form D - 410
by August 15 and marking the “ out of country” indicator on the form.
A return may be filed at any time within the extension period but it must be
filed before the end of the extension period to avoid the late filing penalty.
If the Internal Revenue Service authorizes an extension of time for
federal tax - related deadlines for persons determined to be affected by a
Presidentially declared disaster, North Carolina will grant a similar
extension of time to file a return or report. For North Carolina income tax
purposes, the extension of time does not abate the payment of interest.
7. Amended Returns
North Carolina individual income tax returns may be amended by filing
an amended tax return, Form D - 400X. Instructions for filing the amended
return are provided on the reverse side of the form.
5
TAX RATE SCHEDULE
And your
taxable
If your filing income is But not
status is more than over The Tax is
Single $ 0 $ 12,750 6% of the taxable
income
$ 12,750 $ 60,000 $ 765 + 7% of the
amount over $ 12,750
$ 60,000 $ 120,000 $ 4,072.50 + 7.75% of
the amount over
$ 60,000
$ 120,000 - - - - - - - - - - $ 8,722.50 + 8.25% of
the amount over
$ 120,000
Head of $ 0 $ 17,000 6% of the taxable
Household income
$ 17,000 $ 80,000 $ 1,020 + 7% of the
amount over $ 17,000
$ 80,000 $ 160,000 $ 5,430 + 7.75% of the
amount over $ 80,000
$ 160,000 $ - - - - - - - - - - $ 11,630 + 8.25% of
the amount over
$ 160,000
Married filing $ 0 $ 21,250 6% of the taxable
Jointly or income
Qualifying $ 21,250 $ 100,000 $ 1,275 + 7% of the
Widow( er) amount over $ 21,250
$ 100,000 $ 200,000 $ 6,787.50 + 7.75% of
the amount over
$ 100,000
$ 200,000 - - - - - - - - - - $ 14,537.50 + 8.25% of
the amount over
$ 200,000
Married filing $ 0 $ 10,625 6% of the taxable
Separately income
$ 10,625 $ 50,000 $ 637.50 + 7% of the
amount over $ 10,625
$ 50,000 $ 100,000 $ 3,393.75 + 7.75% of
the amount over
$ 50,000
$ 100,000 - - - - - - - - - - $ 7,268.75 + 8.25% of
the amount over
$ 100,000
8. Tax Liability
If North Carolina taxable income is less than $ 68,000, the tax liability
must be determined by using the Tax Table in the individual income tax
instructions. If taxable income is $ 68,000 or more, use the Tax Rate
Schedule below to compute the tax.
6
II. Subject: Filing Requirements ( G. S. 105- 152)
1. General
The minimum gross income filing requirements under North Carolina
law are different from the filing requirements under the Internal Revenue
Code because North Carolina law does not adjust the standard deduction
and personal exemption for inflation as required by the Internal Revenue
Code. See pages 11 and 12 for the North Carolina standard deduction
and personal exemption amounts. The amounts are reflected in the
charts for minimum gross income filing requirements on pages 7 and 8
that follow.
2. Individuals Required to File a North Carolina Individual Income
Tax Return
The following individuals are required to file a North Carolina individual
income tax return:
a. Every resident of North Carolina whose income for the taxable
year equals or exceeds the amount for the individual’s filing status
shown in Chart A or B which follows.
b. Every part - year resident who received income while a resident of
North Carolina or who received income while a nonresident
attributable to the ownership of any interest in real or tangible
personal property in North Carolina or derived from a business,
trade, profession, or occupation carried on in North Carolina, or
derived from gambling activities in North Carolina and whose total
income for the taxable year equals or exceeds the amount for the
individual’s filing status shown in Chart A or B which follows.
c. Every nonresident who received income for the taxable year from
North Carolina sources that was attributable to the ownership of
any interest in real or tangible personal property in North Carolina
or derived from a business, trade, profession, or occupation carried
on in North Carolina, or derived from gambling activities in North
Carolina and whose total income for the taxable year equals or
exceeds the amount for the individual’s filing status shown in Chart
A or B which follows.
3. Minimum Gross Income Filing Requirements
The minimum gross income filing requirements for most people are
shown in Chart A, on the following page:
7
CHART A— FOR MOST TAXPAYERS
A Return is Required if
Filing Status Federal Gross Income Exceeds
( 1) Single $ 5,500
Single ( age 65 or older) $ 6,250
( 2) Married— Filing Joint Return $ 11,000
Married— Filing Joint Return,
( one age 65 or older) $ 11,600
Married— Filing Joint Return,
( both age 65 or older) $ 12,200
( 3) Married— Filing Separate Return $ 2,500
( 4) Head of Household $ 6,900
Head of Household
( age 65 or older) $ 7,650
( 5) Qualifying Widow( er)
with dependent child $ 8,500
Qualifying Widow( er)
( age 65 or older) $ 9,100
If an individual was not required to file a federal income tax return but
had gross income inside and outside North Carolina that equals or exceeds
the amount for the individual’s filing status in Chart A, a federal return
must be completed and attached to the North Carolina return to show
how the negative federal taxable income was determined.
The minimum gross income filing requirements for children and other
dependents are shown in Chart B on the following page. The filing
requirements in Chart B generally are applicable to those individuals
who can be claimed as a dependent by another person ( such as a parent).
Note: Earned income includes salaries, wages, tips, professional fees,
scholarships that must be included in income, and other
compensation received for personal services.
Unearned income includes taxable interest, dividends, capital
gains, pensions, annuities, and social security benefits.
8
Chart B— FOR CHILDREN AND OTHER DEPENDENTS
Single dependents. Were you either age 65 or older or blind?
No. You must file a return if any of the following apply to you.
• Unearned income was over $ 500
• Earned income was over $ 3,000
• Gross income was more
than the larger of -
• $ 500, or
• Earned income ( up to $ 2,750) plus $ 250
Yes. You must file a return if any of the following apply to you.
• Earned income was over $ 3,750 ($ 4,500 if 65 or older and blind)
• Unearned income was over $ 1,250 ($ 2,000 if 65 or older and blind)
• Gross income was more than -
The larger of- Plus This amount:
• $ 500, or $ 750 ($ 1,500 if 65
• Earned income ( up to $ 2,750) or older and blind)
plus $ 250
Unearned income includes taxable interest, dividends, capital gains, pensions,
annuities, and social security benefits. Earned Income includes salaries, wages,
tips, professional fees, scholarships that must be included in income, and other
compensation received for personal services.
Married dependents. Were you either age 65 or older or blind?
No. You must file a return if any of the following apply to you.
• Gross income was at least $ 10 and your spouse files a
separate return and itemizes deductions.
• Unearned income was over $ 500
• Earned income was over $ 3,000
• Gross income was more
than the larger of -
• $ 500, or
• Earned income up to $ 2,750 plus $ 250
Yes. You must file a return if any of the following apply.
• Earned income was over $ 3,600 ($ 4,200 if 65 or older and blind)
• Unearned income was over $ 1,100 ($ 1,700 if 65 or older and blind)
• Gross income was at least $ 10 and your spouse files a separate
return and itemizes deductions
• Gross income was more than -
The larger of- Plus This amount:
• $ 500, or $ 600 ($ 1,200 if 65
• Earned income up to 2,750 or older and blind)
plus $ 250
}
}
9
4. Joint Returns ( G. S. 105- 152)
G. S. 105 - 152 requires that a husband and wife file a joint State return if:
a. They file a joint federal income tax return and
b. Both spouses are residents of North Carolina or both spouses had
North Carolina taxable income.
All other individuals must file separate returns.
On joint returns, both spouses are jointly and severally liable for the
tax due. However, if a spouse has been relieved of any liability for federal
income tax under Internal Revenue Code Section 6015, that spouse would
not be liable for the corresponding State income tax liability.
If an individual files a joint federal return but files a separate North
Carolina return, the individual must complete a separate federal return
and attach it to the North Carolina income tax return to show how the
federal taxable income would be determined on a separate federal return.
In lieu of completing a separate federal return, an individual may submit
a schedule showing the computation of the separate federal taxable
income. In this case, an individual must attach a copy of the joint federal
return unless the federal return reflects a North Carolina address.
In determining the federal taxable income on the separate federal return,
deductions are allowable only to the spouse responsible for payment of
the item and who actually paid the amount during the tax year. In the
case of a joint obligation, nonbusiness deductions ( except for medical
expenses) are allowable to the spouse who actually paid the item; or if a
joint obligation is paid from a joint checking account, the deductions must
be allocated between the spouses according to their respective adjusted
gross income. In determining the amount of medical expenses paid by
each spouse from a joint checking account, each spouse is considered to
have paid their own medical expenses.
10
III. Subject: Computation of Taxable Income ( G. S. 105- 134.2 -
G. S. 105- 134.5)
1. General
The starting point in determining North Carolina taxable income is
taxable income for federal income tax purposes, subject to the following
additions, deductions and transitional adjustments. These adjustments
do not apply to all individuals. Each individual should determine if any of
the adjustments apply to his or her return.
2. Additions to Federal Taxable Income ( G. S. 105- 134.6)
Federal taxable income must be increased by the following additions
to the extent the amounts are not included in federal taxable income:
a. Interest received upon obligations of states other than North
Carolina and their political subdivisions;
This addition includes that portion of an exempt interest dividend
from a regulated investment company ( mutual fund) that represents
interest on direct obligations of states and their political subdivisions
other than North Carolina. ( See page 53 for additional information
on regulated investment companies.)
b. Any amount allowed as a deduction from gross income that is
taxed by a separate tax under the Internal Revenue Code. This
includes lump - sum distributions from certain employees’ retirement
plans which a taxpayer may elect to exclude from taxable income
in the regular tax computation and compute the tax separately.
c. State, local, and foreign income taxes or general sales taxes deducted
on the federal return.
d. The amount claimed for domestic production activities income. The
federal Jobs Creation Act of 2004 allows a deduction equal to a portion
of the qualified production activities income. North Carolina did not
adopt the federal provision allowing the deduction for domestic
production activities income.
e. The market price of donated gleaned crops for which a tax credit
was claimed on the North Carolina individual income tax return.
f. The difference in the standard deduction for federal and State
income tax purposes and the difference in the personal exemption
for federal and State income tax purposes. These adjustments are
necessary because the federal standard deduction amounts and
personal exemption amounts will be adjusted each year, if necessary,
for inflation. North Carolina does not have a similar provision.
11
Standard Deduction Chart for Most People
Do Not use this chart if you or your spouse were 65 or older or blind,
Or if someone can claim you as a dependent.
Standard Deduction Chart for
People Age 65 or Older or Blind
If someone can claim you as a dependent, use the worksheet for dependents instead.
If your filing status is:
Single 1 $ 3,750
2 $ 4,500
Head of household 1 $ 5,150
2 $ 5,900
Married filing separately 1 $ 3,600
2 $ 4,200
3 $ 4,800
4 $ 5,400
Check if: You were 65 or Older Blind
Your spouse was 65 or Older Blind
Enter the number of boxes checked above
Note: If married filing separately, include the number of
boxes checked for your spouse in the total number only
if your spouse had no gross income and was not claimed
as a dependent by another taxpayer.
If your filing status is: Your standard deduction is:
Single $ 3,000
Married filing jointly/ Qualifying widow( er) $ 6,000
Married filing separately
If spouse does not claim itemized deductions $ 3,000
If spouse claims itemized deductions 0
Head of household $ 4,400
Married filing jointly/ 1 $ 6,600
Qualifying widow( er) 2 $ 7,200
3 $ 7,800
4 $ 8,400
And the
total number
of boxes
you have
checked is:
Your standard deduction is:
The charts that follow show the North Carolina standard deduction
for individuals who are not claimed as dependents by another taxpayer.
The worksheet that follows is used to calculate the North Carolina
standard deduction for individuals who can be claimed as dependents by
another taxpayer.
12
The standard deduction is zero for a married individual filing separately
for federal income tax purposes whose spouse claims itemized deductions.
The standard deduction for nonresident aliens and individuals filing a
short year return due to a change of accounting period is zero.
The personal exemption for North Carolina purposes is $ 2,500 for a
taxpayer whose federal adjusted gross income is less than the amount
shown for his filing status in the chart that follows. For a taxpayer with
federal adjusted gross income equal to or more than the threshold amount,
the personal exemption is $ 2,000.
Filing Status Adjusted Gross Income
Married filing jointly $ 100,000
Head of household $ 80,000
Single $ 60,000
Married filing separately $ 50,000
1. Enter amount of earned income
( Earned income defined below) + $ 250 Enter total 1. ______________
2. Minimum amount. ....................................................................................... 2. ______________
3. Enter the larger of line 1 or line 2. ........................................................... 3. ______________
4. Enter on line 4 the amount shown for your filing status
• Single, enter $ 3,000
• Married filing jointly/
Qualifying widow( er), enter $ 6,000
• Married filing separately, enter $ 3,000
• Head of household, enter $ 4,400 ......................................................... 4. ______________
5. Enter the smaller of lines 3 or 4. If under 65 and not blind,
Stop Here and enter this amount on the appropriate line of
Form D - 400 ................................................................................................. 5. ______________
6. a. Check if: You were 65 or Older Blind
Your spouse was 65 or Older Blind
b. Enter the number of boxes you have checked
Note: If married filing separately, include the number of boxes checked for
your spouse in the total number checked only if your spouse had no gross income
and was not claimed as a dependent by another taxpayer.
c. Multiply $ 750 ($ 600 if married filing jointly or separately,
or qualifying widow( er)) by the number of boxes you
entered on line 6b above and enter the result ................................. 6c. _____________
7. Add lines 5 and 6c. Enter the total here and on the appropriate line
of Form D - 400 ............................................................................................ 7. ______________
Earned income includes salaries, wages, tips, professional fees, and other compensation received
for personal services you performed. It also includes any amount received as a scholarship that you
must report in income.
Standard Deduction Worksheet for Dependents
Use this worksheet only if someone can claim you as a dependent
$ 500
13
g. The amount of federal estate tax that is attributable to income in
respect of a decedent and that is deducted under Section 691 ( c)
of the Internal Revenue Code.
h. The amount by which the basis of property for federal purposes
exceeds the basis for State purposes upon disposition of the
property.
i. The amount of net operating loss carried over to a taxable year to
the extent the loss is not absorbed and will be carried forward to
subsequent years.
j. The amount of all tax credits passed through to an individual by an
S corporation, with the exception of the credit for tax paid to another
state or country and the credit for certain real property donations.
Example: An S corporation with two 50% shareholders claims a
$ 1,000 tax credit for creating jobs. Each shareholder claims the
jobs tax credit of $ 500 on their individual income tax return. An
addition to federal taxable income of $ 500 is required on each
shareholder’s State return.
k. With respect to a child’s unearned income reported by a parent,
the amount of the child’s unearned income in excess of $ 500 but
not exceeding $ 1,600. When a parent elects to report a child’s
unearned income, the child is treated as having no gross income
for the year and is not required to file a federal income tax return.
A parent electing to report a child’s unearned income for federal
tax purposes must add to 2005 federal taxable income the amount
of the child’s unearned income in excess of $ 500 but not exceeding
$ 1,600.
l. The amount of qualifying expenses for which an income tax credit
for qualifying expenses of a film or television production company
was claimed under G. S. 105 - 151.29.
3. Deductions from Federal Taxable Income ( G. S. 105- 134.6)
Federal taxable income must be decreased by the following deductions
to the extent the amounts are included in federal taxable income:
a. Interest upon direct obligations of the United States or its
possessions;
Interest earned from obligations that are merely backed or
guaranteed by the United States Government will not qualify for
deduction from an individual’s income. The deduction from income
will not apply to distributions which represent gain from the sale or
other disposition of the securities, nor to interest paid in connection
with repurchase agreements issued by banks and savings and loan
associations. The deduction will not apply to any portion of a
distribution from an individual retirement account ( IRA).
The following are examples of interest on bonds, notes, or other
obligations that must be deducted from federal taxable income, if
such bonds, notes, or other obligations are direct obligations of:
14
( 1) Puerto Rico, the Virgin Islands and Guam
( 2) A Federal Land Bank
( 3) A Federal Home Loan Bank
( 4) A Federal Intermediate Bank
( 5) Farm Home Administration
( 6) Export - Import Bank of the United States
( 7) Tennessee Valley Authority
( 8) Banks for Cooperatives
( 9) U. S. Treasury bonds, notes, bills, certificates and savings bonds
( 10) Production Credit Association
( 11) Student Loan Marketing Association
( 12) Commodity Credit Corporation
( 13) Federal Deposit Insurance Corporation
( 14) A Federal Farm Credit Bank
( 15) Federal Financing Bank
( 16) Federal Savings and Loan Insurance Corporation
( 17) General Insurance Fund
( 18) United States Postal Service
( 19) Resolution Funding Corporation
( 20) Financing Corporation ( chartered by the Federal Housing
Finance Board — 12 USCS 12 - 1441)
b. Interest on bonds, notes, and other obligations of the State of North
Carolina or any of its political subdivisions;
c. Interest on obligations and gain from the sale or disposition of
obligations issued before July 1, 1995 if North Carolina law under
which the obligations were issued specifically exempts the interest
or gain ( With respect to North Carolina obligations issued after July 1,
1995, the income tax treatment of gains from the sale or disposition of
such obligations is the same for federal and State purposes.);
Examples:
( 1) Interest on bonds, notes, debentures, or other evidence of
the indebtedness issued under G. S. 131E - 28 by the North
Carolina Hospital Authorities, including gain from the sale
or exchange of these obligations.
( 2) Interest on bonds, notes, debentures, or other evidence of
indebtedness issued by the North Carolina Medical Care
Commission under the Health Care Facilities Finance Act
under the provisions of G. S. 131A - 21. Gain from the sale or
exchange of these obligations may also be deducted.
( 3) Interest and gain derived from obligations issued by the North
Carolina Housing Finance Agency under G. S. 122A - 19.
( 4) Interest and gain on bonds issued by the North Carolina
State Ports Authority under G. S. 143B - 456( g).
( 5) Interest on bonds, notes, debentures, and any other evidence
of indebtedness issued by a North Carolina Housing
Authority ( including any corporate agent authorized by
15
Article 1 of Chapter 157 of the General Statutes to exercise
the powers of the authority) under the provisions of G. S.
157 - 26. Gain from the sale or exchange of these obligations
is not deductible.
( 6) Interest and gain derived from bonds issued under the Joint
Municipal Electric Power and Energy Act under G. S. 159B - 26.
( 7) Interest on bonds issued by the authorities created under
the Industrial and Pollution Control Facilities Financing Act,
G. S. 159C - 14.
( 8) Income from securities, evidence of indebtedness, and shares
of capital stock issued by a corporation organized to promote,
develop, and advance the prosperity and economic welfare of
the State of North Carolina under the provisions of G. S. 53A -
15. Gain from the sale or exchange of such obligations is deductible.
( 9) Income from bonds issued by boards of trustees of State
supported colleges and universities in North Carolina including
any gain from the sale or exchange of them under G. S. 116 - 183
and 116 - 196.
( 10) Interest and gain received from bonds and notes issued under
the provision of the Higher Education Facilities Finance Act
by the North Carolina Educational Facilities Finance Agency
under G. S. 115E - 21.
( 11) Interest and gain received on obligations issued under
Chapter 122D ( The North Carolina Agriculture Finance Act)
by the North Carolina Agriculture Finance Authority under
G. S. 122D - 14.
d. Taxable portion of social security benefits received under Title II
of the Social Security Act and any Tier I or Tier II Railroad
Retirement benefits received under the Railroad Retirement Act
of 1937;
e. An amount by which any federal income tax deduction is
disallowed because of the allowance of a federal income tax credit
for part or all of the expense comprising the deduction to the extent
that a similar State income tax credit is not allowed;
Example 1: If an individual itemizes deductions and claims the
mortgage interest tax credit on the federal tax return because of
participating in the mortgage credit certificate program ( MCC),
the individual may reduce North Carolina taxable income by the
amount that the mortgage interest deduction was reduced due to
claiming the mortgage interest credit on the federal tax return.
Example 2: If an individual claimed the Hope or Lifetime Learning
tax credit on the federal return in lieu of the deduction for higher
education expenses allowed under Section 222 of the Internal
Revenue Code, the individual may claim a deduction of up to $ 4,000
for such expenses on the 2005 State return.
16
f. Refunds of state, local, and foreign income taxes;
g. Up to $ 4,000 in retirement benefits from one or more federal,
state, or local government retirement plans ( See IV. Bailey
Settlement on page 23 to determine if more than $ 4,000 of
government retirement benefits may be deducted.)
h. Up to $ 2,000 in retirement benefits from one or more private
retirement plans; If an individual receives federal, state, or local
government retirement benefits and also receives other qualified
retirement benefits, the total deduction is limited to $ 4,000. For
married couples filing a joint return, the maximum dollar amount
of retirement benefits that may be deducted from federal taxable
income applies separately to the benefits received by each spouse,
so that the maximum deduction on a joint return is $ 8,000.
The $ 4,000 deduction is applicable to retirement benefits received from the
governments of territories and possessions of the United States.
If an individual received retirement benefits during the year from one
or more private retirement plans other than state, local, or federal
government retirement plans, the individual may deduct the amount
received or $ 2,000, whichever is less. Married individuals filing a
joint return where both received such retirement benefits may each
deduct up to $ 2,000 for a potential total deduction of $ 4,000.
“ Retirement benefits” are amounts paid to a former employee or
to a beneficiary of a former employee under a written retirement
plan established by the employer to provide payments to an
employee or beneficiary after the end of the employee’s
employment with the employer where the right to receive the
payment is based upon the employment relationship. For self -
employed individuals, retirement benefits are amounts paid to an
individual, or beneficiary under a written retirement plan established
by the individual to provide payments after self - employment ends.
Retirement benefits also include amounts received from an
individual retirement account or from an individual retirement
annuity ( IRA).
An individual is not required to have ceased employment to qualify
for the $ 2,000 deduction for distributions from an individual
retirement account or an individual retirement annuity.
The deduction for retirement benefits is allowed only to the extent
the benefits are included in federal taxable income. If an individual
elects to roll - over the distribution from an employer’s plan or from
an individual retirement account, no deduction is allowed since the
amount rolled over is not included in taxable income.
A change in the structure of a corporate employer which causes a
distribution to be paid to the employee from the employer’s
retirement plan does not entitle the employee to claim the deduction
for retirement benefits from such distribution. For example,
Company A is merged with Company B. An employee of A
17
continues to work for the merged company. During the tax year,
the employee received a distribution of $ 5,000 representing the
employee’s total credit in the non - contributory retirement plan of
Company A. The employee would not be entitled to the $ 2,000
deduction since the employee had not ceased employment.
Since short - term disability benefits from the Disability Income Plan
of North Carolina administered for the benefit of North Carolina
teachers and state employees are not paid to a former employee
under a retirement plan after the end of the employee’s employment,
the benefits are not subject to the $ 4,000 deduction from federal
taxable income. Long - term disability benefits are payable after
the conclusion of the short - term disability period or after salary
continuation payments cease, whichever is later. Recipients of
long - term disability benefits under the Disability Income Plan of
North Carolina are former employees and they are entitled to the
$ 4,000 deduction from federal taxable income.
Benefits paid to federal civil service employees who become
disabled prior to becoming age 60 upon separation from service
are paid to a former employee under a retirement plan after the
end of the employee’s employment and are subject to the $ 4,000
deduction from federal taxable income.
Survivors of a member of the armed forces who receive benefits
from the Retired Serviceman’s Family Protection Plan or the
Survivor’s Benefits Plan as the result of taking a reduction in
retirement pay are subject to the deduction of up to $ 4,000 from
federal taxable income.
i. The amount of North Carolina inheritance or estate tax paid that
is attributable to an item of income in respect of a decedent;
The deduction from federal taxable income is determined by multiplying
the amount of North Carolina inheritance or estate tax paid on all
property transferred to the particular beneficiary, less the North Carolina
inheritance or estate tax which would have been paid if the item of
income in respect of a decedent had not been included, by a fraction,
the numerator of which is the income in respect of a decedent the
beneficiary included in federal taxable income, as adjusted, and the
denominator of which is the total income in respect of a decedent
transferred to the beneficiary. The deduction is allowable in the year
the item of income is included in federal taxable income.
j. Income earned or received by an enrolled member of a federally
recognized Indian tribe if such income is derived from activities on
a federally recognized Indian reservation while the member resided
on the reservation. Intangible income having a situs on the reservation
and retirement income associated with activities on the reservation
are considered income derived from activities on the reservation.
k. Repayments of items of income included in gross income in a
prior year under the claim - of - right doctrine for which the taxpayer
18
reduces his tax under Section 1341 of the Internal Revenue Code
in the year of repayment;
For federal income tax purposes, if the repayment claimed under a
claim of right is substantial ( more than $ 3,000) and there is insufficient
income in the later year to offset the deduction, an individual may
claim a credit if the benefit received by claiming the credit is greater
than that received by claiming a deduction for the repayment. A
taxpayer who qualifies for the credit on the federal return is still entitled
to the deduction for the amount repaid on the State return. The taxpayer
is also considered to have made a payment of North Carolina income
tax on the repayment. The payment, which is applied against the tax
liability for the year in which the repayment was made, is the amount
the tax was increased in the earlier year because the income was
included in gross income minus the amount the tax for the current
year was decreased because the repayment was deductible. Individuals
may claim the payment on the individual income tax return by including
the payment on the same line as S corporation payments.
Example: In 2004, a single taxpayer reported North Carolina
taxable income of $ 25,000 on which he paid tax of $ 1,624. The
taxpayer’s only income was sales commissions. In 2005, it is
determined that the commissions were erroneously computed for
2004. Accordingly, the taxpayer pays back $ 8,000 of the commissions.
The North Carolina taxable income for 2005 without regard to the
$ 8,000 repayment is $ 4,000. The taxpayer qualifies for a credit on
the federal return for the amount repaid. The tax payment to be
claimed on the 2005 North Carolina return is determined as follows:
2004
Tax on $ 25,000 = $ 1,624
Tax on $ 17,000 ($ 25,000 - $ 8,000) = 1,064
$ 560
2005
Tax on $ 4,000 = $ 242
Tax after deducting $ 8,000 payment = 0
$ 242
Payment to be claimed on the 2005
North Carolina return $ 318
l. The amount by which the basis of property for State purposes exceeds the
basis for federal purposes upon disposition of the property. The deduction
can be claimed only in the year in which the property is disposed.
m. Up to $ 35,000 of any severance wages received as a result of a
taxpayer’s permanent, involuntary termination from employment
through no fault of the employee is deductible from federal taxable
income. The severance wages deducted as a result of the same
termination may not exceed $ 35,000 for all taxable years in which the
19
wages were received. “ Stay on pay” does not qualify for the deduction.
Severance wages do not include payments that represent compensation
for past or future services. Compensation for past or future services
includes payment for any of the following:
( 1) Accumulated sick leave, vacation time, or other unused benefits;
( 2) Bonuses based on job performance; and
( 3) Payments in consideration of any agreement not to compete with the
employer or in consideration of a contractual or legal claim.
n. See IV. Bailey Settlement.
o. Interest, investment earnings, and gains of a trust established by two
or more manufacturers that signed a settlement agreement with the State
to settle claims for damages attributable to a product of the manufacturers.
p. The amount paid to an individual from the Disaster Relief Reserve
Fund in the Office of State Budget, Planning, and Management for
hurricane relief or assistance, but not including payments received for
goods or services.
q. An amount equal to 20 percent of the total additional first - year
depreciation an individual added back on the 2002, 2003, and 2004
State returns. North Carolina did not adopt the additional first -
year depreciation provisions in the federal Jobs Creation and Worker
Assistance Act of 2002 or the federal Jobs and Growth Tax Relief
Reconciliation Act of 2003. Instead, an adjustment was required
on the 2002, 2003, and 2004 returns for a certain percentage of
the first - year depreciation claimed on the federal return for the
applicable year. Any amount of additional first - year depreciation
that an individual added to federal taxable income on the 2002,
2003, or 2004 State returns may be deducted in five equal
installments beginning with the State tax return for 2005.
If a taxpayer disposes of an asset on which additional first - year
depreciation was added back on the 2002, 2003, or 2004 State
return, the taxpayer is entitled to claim the 20 percent deduction
over the five year period even though the taxpayer no longer owns
the asset.
If a taxpaying entity that added back additional first - year
depreciation on the State return merges with another entity, the
new entity is not entitled to claim the 20 percent deduction.
4. Transitional Adjustments ( G. S. 105- 134.7)
The following transitional adjustments are required because of
differences in the way State and federal law treated certain tax
transactions prior to January 1, 1989.
a. Amounts that were included in the basis of property under federal
law but not under State law prior to January 1, 1989, must be
added to taxable income in the year of disposition of the property.
These adjustments include the increase in basis for federal gift tax
20
paid on property received as a gift and in certain cases where the
individual was permitted under federal law to capitalize certain
expenditures for interest and taxes.
b. Amounts that were included in the basis of property under State
law but not under federal law prior to January 1, 1989, must be
deducted from an individual’s taxable income in the year of
disposition of the property. Deductions of this type include the
increase in basis for State gift tax paid on property received as a
gift and certain business expenditures that an individual elected to
expense under Section 179 of the Internal Revenue Code but which
were required to be capitalized for State income tax purposes.
c. A loss or deduction that was incurred or paid and deducted in full
for North Carolina income tax purposes under prior State law in a
taxable year beginning before January 1, 1989, but was carried
forward and deducted from federal taxable income in a taxable year
beginning on or after January 1, 1989, must be added to taxable income.
Example: The full amount of a capital loss incurred in 1988 would
have been deductible on an individual’s 1988 State income tax
return but on his federal income tax return the amount of the
deductible loss would have been limited to his capital gains plus
$ 3,000 ($ 1,500 if married and filing a separate return). Any
remaining loss could be carried forward to subsequent tax years
and deducted on his federal income tax return in computing his
federal taxable income. In this instance, the individual must add
back each year that portion of the 1988 loss deducted from his
federal taxable income in arriving at the amount of his North
Carolina taxable income.
In determining the amount of a capital loss to add back, short - term
capital losses from taxable years beginning prior to January 1,
1989, must be applied before applying short - term capital losses
incurred in taxable years beginning on or after January 1, 1989,
and before applying long - term capital losses from any year. Long -
term capital losses from taxable years beginning prior to January
1, 1989, must be applied before applying long - term capital losses
incurred in taxable years beginning on or after January 1, 1989.
Example: An individual carries over $ 6,000 of capital losses from
years beginning prior to January 1, 1989, consisting of $ 4,000 of
short - term losses and $ 2,000 of long - term losses. In 1989, the
individual incurs additional capital losses of $ 2,500, consisting of
$ 1,500 of short - term losses and $ 1,000 of long - term losses. The
individual claims a capital loss deduction of $ 3,000 on his federal
income tax return. In 1990 and 1991 the individual has no additional
capital gains or losses and claims a $ 3,000 capital loss carry - over
on his 1990 federal income tax return and the balance of $ 2,500
capital loss carry - over on his 1991 federal income tax return. The
taxpayer would be required to add back the following amounts as
transitional adjustments: 1989 — $ 3,000 ( a portion of the short -
21
term capital loss from 1988); 1990 — $ 1,500 consisting of the
$ 1,000 balance of the 1988 short - term loss and $ 500 of the 1988
long - term loss; 1991 — $ 1,500 consisting of the remaining 1988
long - term loss carry - over.
Example: Generally, for federal income tax purposes for tax years
beginning on or after January 1, 1987, to the extent that the total
deductions from passive activities exceed the total income from
such activities for the tax year, the excess ( passive activity loss) is
not allowed as a deduction for that year. A disallowed passive loss
is allowed to be carried forward as a deduction from passive
activity income in the next succeeding tax year. Generally, losses
from passive activities may not be deducted from other types of
income ( e. g. wages, interest, or dividends). A passive activity is
one that involves the conduct of any trade or business in which the
taxpayer does not materially participate. Any rental activity is a
passive activity regardless of whether the taxpayer materially
participates. Special rules apply to rental activities. Under State
law, a passive loss carried forward from a tax year beginning prior
to January 1, 1989, must be added back to federal taxable income
since the entire loss was deductible on the taxpayer’s return for
the year the loss was incurred.
d. Amounts deducted on an individual’s federal income tax return as
net operating losses brought forward from tax years beginning
prior to January 1, 1989, must be added to federal taxable income.
For tax years prior to January 1, 1989, State law allowed a net
economic loss to be carried forward to subsequent years but was
computed differently from the federal net operating loss. Prior State
law did not permit the loss to be carried back to prior tax years as did
federal law. See V. Net Operating Losses for additional information.
Example: An individual sustains a business loss of $ 100,000 in
1988, had no other business income or business expenses for that
year, and received interest income of $ 82,000 from City of Raleigh
bonds during the taxable year. For federal income tax purposes,
the individual would have sustained a net operating loss of $ 100,000.
If the individual had no income in the prior three tax years to
offset the net operating loss, he could carry the $ 100,000 loss
forward for up to 15 years and deduct it as a net operating loss on
his subsequent federal income tax returns. Under prior State law,
the individual would have incurred a net economic loss of $ 18,000
( business loss of $ 100,000 less nontaxable income of $ 82,000)
that could be carried forward to up to five years after reducing it
by both taxable and nontaxable income. In this situation, the
individual must add back the net operating loss deduction claimed
on his federal income tax return.
e. Adjustments must also be made in the taxable income of a
shareholder of an S corporation. For a discussion of the tax status
22
of distributions from S corporations to shareholders in tax years
beginning on or after January 1, 1989, see VII. S Corporations.
f. Under the “ tax benefit rule,” the recovery of an amount deducted
or credited in an earlier year is included in federal taxable income
in the current ( recovery) year, except to the extent the earlier
year’s deduction or credit did not reduce federal income tax
imposed in that year. Income attributable to such recovery items
which did not provide a tax benefit for federal income tax purposes
but did provide a tax benefit for State purposes for taxable years
beginning prior to January 1, 1989, must be added to federal taxable
income.
Other additions and deductions to federal taxable income may be
required to ensure that the transition to the tax changes effective January
1, 1989, does not result in the double taxation of income, the exemption
of otherwise taxable income or double allowance of deductions.
23
V. Subject: Bailey Settlement
As a result of the North Carolina Supreme Court’s decision in Bailey
v. State of North Carolina and the settlement subsequently reached in
that case, North Carolina may not tax retirement benefits received by a
retiree ( or by a beneficiary of a retiree) from qualifying State, local, or
federal retirement systems if the retiree was vested in the retirement
system as of August 12, 1989. For most government retirement sys -
tems, a person is vested if the person had five or more years of credit -
able service in a qualifying State, local or federal retirement system as of
August 12, 1989. For certain retirement systems, the vesting period is less.
1. Qualifying State or Local Retirement System
The following retirement systems were designated as a North Carolina
state or local governmental retirement system:
System Law Creating the System
North Carolina Teachers’ and State Employees’ G. S. 135, Article 1
Retirement System ( TSERS)
Optional Retirement Program available to G. S. 105 - 135 - 5.1
administrators and faculty of the University of North
Carolina system in lieu of TSERS
North Carolina Local Governmental Employees’ G. S. 128, Article 3
Retirement System
North Carolina Consolidated Judicial Retirement G. S. 135, Article 4
System
North Carolina Legislative Retirement System G. S. 120, Article 1A
North Carolina Disability Income Plan ( both short - G. S. 135, Article 6
term and long - term disability benefits)
North Carolina Supplemental Retirement Income Plan G. S. 135, Article 5
North Carolina Supplemental Retirement Income Plan G. S. 143 - 166.30( d)
for State Law Enforcement Officers
North Carolina Deferred Compensation Plan G. S. 143B, Article 9
North Carolina National Guard Pension Fund G. S. 127A - 40
North Carolina Sheriffs’ Supplemental Pension Fund G. S. 143, Article 12H
North Carolina Registers of Deeds’ Supplemental G. S. 161, Article 3
Pension Fund
North Carolina Supplemental Retirement Plan for G. S. 143 - 166.50( e)
Local Governmental Law Enforcement Officers
Separate Insurance Benefits Plan for State and Local
Governmental Law Enforcement Officers G. S. 143 - 166.60
North Carolina Firemen’s and Rescue Squad Workers’
Pension Fund G. S. 58, Article 86
24
No local government optional contribution plans, similar to the State’s
Supplemental Retirement Income Plan and Deferred Compensation Plan,
were afforded tax exemption prior to August 12, 1989. Therefore,
retirement benefits from local optional contribution plans are not subject
to future tax exemption.
Teachers and other employees of North Carolina’s public schools
have the option of contributing to optional contribution plans established
pursuant to section 403( b) of the Code. Distributions from these plans
may not be excluded from taxable income under the settlement.
2. Vesting Period for Qualifying State or Local Retirement Systems
The general rule is that a participant in a qualifying State or local retirement
system is vested if the participant had five or more years of creditable service
as of August 12, 1989. The general rule does not apply to qualifying optional
contribution plans, however, or to certain other qualifying plans.
Participants in the State’s Supplemental Retirement Income Plan
( Internal Revenue Code § 401( k)) or the State’s Deferred Compensation
Plan ( Code § 457) are vested in the plan as of August 12, 1989, if they
contributed or contracted to contribute to the plan by August 12, 1989. If
the participant contributed any money to a plan before August 12, 1989,
all future withdrawals from that plan are excludable from tax.
Contributions to one plan prior to August 12, 1989, do not qualify
contributions to the other plan as vested. If a State employee began
contributing to the § 401( k) plan in June 1989, and to the § 457 plan in
October 1989, the employee is vested only in the § 401( k) plan. Participants
in the State’s Supplemental Retirement Income Plan or the State’s
Deferred Compensation Plan may have chosen an annuity as an
investment option. In some cases, they receive the annuity payments
and the subsequent tax information statement from the annuity company
instead of the plan administrator. These amounts also qualify for future
tax exemption if the retiree was vested.
Participants in the North Carolina Firemen’s and Rescue Workers’
Pension Plan are vested as of August 12, 1989, only if the individual had
both five years of service and had paid five years of contributions to the
plan by August 12, 1989. Sheriffs receiving benefits from the North
Carolina Sheriffs’ Supplemental Pension Fund and Registers of Deeds
receiving benefits from the North Carolina Registers of Deeds’
Charlotte Firefighters’ Retirement System Session Laws 1947, Chapter 926, § 6( c)
Firemen’s Supplemental Fund of Hickory Session Laws 1971, Chapter 65
Winston - Salem Police Officers’ Retirement System Session Laws 1939, Chapter 296
Separate Insurance Benefits Plan for State and G. S. 143 - 166.60
Local Government Law Enforcement Officers
New Hanover County School Employees’ 1979 Session Laws, Chapter 1307
Retirement Plan
25
Supplemental Pension Fund are vested as of August 12, 1989, only if the
sheriff or the register of deeds ( not a deputy or assistant) had five years
of service as a sheriff or a register of deeds and five years of participation
in the Local Government Employees’ Retirement System ( or equivalent
local plan) by August 12, 1989.
An employee in a qualifying State or local government retirement
system who was vested prior to August 12, 1989, and who leaves
employment remains vested if the employee later returns to work, provided
the employee did not withdraw his or her contributions to the retirement
system. If the employee withdrew his or her contributions, the employee
is no longer vested in the retirement system, even if the employee
subsequently buys back the service time, unless the employee returned
to employment in time to become vested again before August 12, 1989.
3. Qualifying Federal Retirement Systems
The following retirement systems were designated as a federal
governmental retirement system:
• Federal Civil Service Retirement System
• Federal Employees’ Retirement System
• Lighthouse Retirement System
• Thrift Savings Plan
• Foreign Service Retirement and Disability System and Pension System
• Military Retirement System
• Coast Guard Retirement System
• Central Intelligence Agency Retirement System
• Commissioned Corps of the Public Health Service Retirement System
• Comptrollers’ General Retirement Plan
• Judicial Plans & Pay for Federal Judges Treated as Retirement Pay by Federal Law, including:
- Judicial Retirement System
- Judicial Survivors’ Annuities System
- Court of Federal Claims Judges’ Retirement System
- Court of Veterans Appeals Judges’ Retirement Plan
- Judicial Officers’ Retirement System ( for Bankruptcy Judges and Magistrates)
- United States Tax Court Retirement Plan
- United States Tax Court Survivors’ Annuity Plan
- Retirement Plans for District Court Judges for the Northern Mariana Islands,
the Virgin Islands, and Guam
- Court of Appeals for the Armed Forces Judges Retirement System
• National Oceanic and Atmospheric Administration Retirement System
• Tennessee Valley Authority Retirement System and TVA Savings and Deferral
Retirement Plan
• Financial Institutions Retirement Fund ( Office of Thrift Supervision Employees)
• Federal Home Loan Bank Board Retirement Systems
• Federal Home Loan Mortgage Corporation Plan
• Federal Reserve Employees Retirement Plans and Thrift Plan
• Nonappropriated fund plans, including:
- Retirement Annuity Plan for Employees of Army and Air Force Exchange Service
- Supplemental Deferred Compensation Plan for Members of the
Executive Management Program ( Army and Air Force Exchange Service)
- Nonappropriated Fund Retirement Plan for Civilian Employees
- United States Army Nonappropriated Fund Retirement Plan
- Retirement Plan for Civilian Employees of United States Marine Corps Morale,
Welfare, and Recreation Activities and Miscellaneous Nonappropriated Fund
Instrumentalities
- Navy Exchange Service Command Retirement Plan
- Navy Nonappropriated Fund Retirement Plan for Employees of Civilian Morale,
Welfare, and Recreation Activities
- Norfolk Naval Shipyard Pension Plan
- Retirement Savings Plan and Trust for Employees of the Army and Air Force
Exchange Service
- Coast Guard Nonappropriated Fund Retirement Plan
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• District of Columbia Police Officers and Fire Fighters’ Retirement Fund and
Related Funds ( including payments to Secret Service and U. S. Park Police
covered by the Fund)
• District of Columbia Teachers’ Retirement Fund and Related Funds
• District of Columbia Judges’ Retirement Fund and Related Funds
• Uniformed Services University of the Health Sciences Plan
• Smithsonian Institution Defined Contribution Retirement Plan
• USDA Graduate School Plan
4. Vesting Period for Qualifying Federal Retirement Systems
Generally, participants in the qualifying federal retirement systems listed
above, including military retirees, are vested for purposes of the settlement if
they had five or more years of creditable service as of August 12, 1989. The
general rule, however, does not apply to the Thrift Savings Plan.
The Thrift Savings Plan has both an employee and an employer
component. The employee component is similar to the State’s § 401( k)
and § 457 plans and allows the employee to voluntarily contribute to the
Plan. The employee is vested in the employee component if the employee
first made a contribution to the plan prior to August 12, 1989. The employer
component includes both contributions by the employer of a fixed
percentage of the employee’s salary and contributions by the employer
that match the employee’s voluntary contributions. The employee is also
vested in the employer matching contributions if the employer first made
a matching contribution prior to August 12, 1989. An employee is vested
in the employer fixed component only if the employee had three years of
service ( two years of service for certain highly ranked employees) as of
August 12, 1989. One exception to the three - year rule is that an employee
who died prior to completing the mandatory three years is still considered
vested if the date of death was on or before August 12, 1989.
As explained above, it is possible for a participant in the Federal Thrift
Savings Plan to be vested as of August 12, 1989, in some components of the
plan while at the same time not being vested in other components. The
annual tax information statement ( Form 1099 - R) does not distinguish between
the various components when reporting the amount distributed during the
year; therefore, the recipient cannot readily determine the amount to exclude
from North Carolina income tax. When a participant in the plan ceases
employment, the recipient is provided a Form TSP - 8, Thrift Savings Plan
Participant Statement, that identifies the cash balances in the various
components. To determine the proper amount to exclude, the recipient should
multiply the annual distribution by a fraction, the numerator of which is the
balance of the components in which the recipient is vested as of August 12,
1989. The denominator of the fraction is the total cash balance of all
components. That same fraction will be used for each year the recipient
receives distributions from the plan.
5. Rollover Distributions with Respect to Bailey Retirement Plans
The Economic Growth and Tax Relief Reconciliation Act of 2001 made
numerous changes with respect of pension portability. Beginning in 2002,
distributions from most types of retirement plans may be rolled over into
another retirement plan or into an IRA. Because rollover distributions
lose their character upon rollover, all distributions from a qualifying Bailey
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retirement account in which the employee/ retiree was “ vested” as of
August 12, 1989, are exempt from State income tax regardless of the
source of the funds contained in the account. Conversely, qualifying tax -
exempt Bailey benefits rolled over into another retirement plan lose their
character and would not be exempt upon distribution from the other plan
unless that plan is a qualifying Bailey retirement account in which the
employee was vested as of August 12, 1989. ( Rollovers to IRAs will
always result in a loss of tax - exempt status since IRAs do not qualify
under the Bailey settlement.)
6. Benefits from Other Retirement Plans
Retirees receiving benefits from government retirement plans of other
states or territories were not class members in Bailey and are not entitled to
recovery of taxes paid in earlier years or to tax exemption in future years,
except for the $ 4,000 deduction provided by G. S. 105 - 134.6( b)( 6). Private
retirement benefits remain taxable except for the $ 2,000 deduction.
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V. Subject: Net Operating Losses ( G. S. 105- 134.7)
Prior to 1989, North Carolina law provided a measure of relief to
individual income taxpayers who incurred economic misfortune by
allowing losses qualifying as net economic losses as defined by G. S.
105 - 147( 9)( d)( 2) to be carried forward and deducted from future gross
income. With the adoption of federal taxable income as the starting point
in determining North Carolina taxable income in 1989, net operating losses
were recognized for State individual income tax purposes. The primary
differences between net operating losses and net economic losses are
( 1) nontaxable income is used to reduce the amount of a net economic
loss but is not used to reduce the amount of net operating loss, and ( 2)
net economic losses can only be carried forward while net operating
losses can be carried back and/ or forward.
1. Determining Net Operating Losses
Since federal taxable income is the starting point for determining North
Carolina taxable income, the amount of net operating loss determined
for federal income tax purposes is also the net operating loss for State
income tax purposes. Although adjustments to federal taxable income
may be required which cause North Carolina taxable income to be
different than federal taxable income in the year the loss is incurred, the
law does not require or permit a separate calculation of a net operating
loss for State purposes. The amount of net operating loss is the same for
State and federal purposes. However, a nonresident or part - year resident
must make an additional calculation to determine the portion of the total
net operating loss that is from North Carolina sources.
2. Net Operating Loss Carryovers
a. Since federal taxable income is the starting point for determining
North Carolina taxable income, the amount of net operating loss
carried over and absorbed for federal purposes is the same amount
carried over and deducted for State purposes. “ Absorbed” means
the amount of net operating loss carried to a year less the amount
of net operating loss carried forward from that year. If, in the year
to which the loss is carried, adjustments are required to the State
return which result in the taxpayer not receiving full benefit of the
carryover, no additional carryover of the portion of the loss not
resulting in a benefit is permitted.
b. For any year in which a net operating loss is carried over but not
completely absorbed for federal purposes, an addition to federal
taxable income is required on the State return for the amount of
net operating loss carried forward from that year.
Example: A taxpayer incurs a net operating loss of $ 75,000
in 2005. The taxpayer amends his 2003 federal return to
carry back the net operating loss and deducts the entire
loss in arriving at federal taxable income. Only $ 50,000 of
the loss is absorbed and $ 25,000 is carried forward to the 2004
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federal return. To determine North Carolina taxable income,
the taxpayer must make an addition to federal taxable income,
as amended, of $ 25,000 on his amended 2003 State return.
c. Because North Carolina did not recognize net operating losses before
1989, a taxpayer may not carry forward a loss incurred prior to 1989.
G. S. 105 - 134.7( a)( 6) requires an addition to federal taxable income
for the amount of net operating loss carried forward from a tax year
prior to 1989 and deducted in arriving at federal taxable income.
3. Effect of Residency Status on Net Operating Losses
As stated earlier, the amount of net operating loss carried over and
absorbed for federal tax purposes is also the amount carried over and
deducted for State tax purposes. If the taxpayer is a nonresident or a
part - year resident in the year the net operating loss is incurred and a
resident in the year to which the loss is carried, the taxpayer receives
the full benefit of the deduction, regardless of whether the net operating
loss resulted from North Carolina source activities. If the taxpayer is a
resident in the year the net operating loss is incurred and a nonresident
or part - year resident in the year to which the loss is carried, the taxpayer
may subtract the entire portion of the net operating loss carried over and
absorbed for federal purposes that year from North Carolina source
income in the numerator of the fraction used to calculate North Carolina
taxable income for nonresidents and part - year residents. If the taxpayer
is a nonresident or a part - year resident in both the year the net operating
loss is incurred and the year to which the loss is carried, the taxpayer
must determine the portion of the net operating loss that was from North
Carolina sources. The numerator of the fraction is reduced by the
attributable portion of the North Carolina source net operating loss while
the denominator is reduced by the portion of the total net operating loss
carried over and absorbed in that year for federal purposes.
Example: A nonresident taxpayer incurs a net operating loss of $ 10,000
in 2005, $ 7,000 of which is from North Carolina sources. The portion
of the net operating loss that is from North Carolina sources is .70
($ 7,000 divided by $ 10,000). If the taxpayer carries the loss back to
2003 and deducts $ 4,000 in that year, the portion of that loss deemed
to be from North Carolina sources and subtracted in determining the
numerator of the fraction is $ 2,800 ($ 4,000 multiplied by .70). The
denominator is reduced by the entire $ 4,000.
The North Carolina source net operating loss is apportioned to all years
to which the total net operating loss is carried even if the taxpayer has
no other North Carolina source income in those years to which the net
operating loss may be applied.
4. Claiming a Net Operating Loss
a. Carrying back a net operating loss. – For federal tax purposes, a
taxpayer carrying back a net operating loss may use Federal Form
1040X or, if a refund is due, Federal Form 1045. North Carolina
does not have a form similar to Federal Form 1045; therefore, the
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taxpayer must use Form D - 400X to carry back the loss. A copy
of Federal Form 1045, including Schedule A, must be provided for
each year to which the loss is carried back. For any year in which
the loss is carried back but not completely absorbed, a copy of
Schedule B of Federal Form 1045 must also be provided. In lieu
of Federal Form 1045, a worksheet containing the same information
as Federal Form 1045 is acceptable.
b. Carrying a net operating loss forward. – For federal tax purposes,
a taxpayer carrying a net operating loss forward reports the loss
as “ Other Income” on the federal return. A copy of Federal Form
1045, Schedule A, or similar worksheet identifying the year in which
the net operating loss was incurred and showing how the net
operating loss was calculated must be attached to each State return
to which the loss is carried forward. For any year in which the
loss is carried forward but not completely absorbed, a copy of the
Worksheet for NOL Carryover included in Federal Publication
536 or a similar worksheet must also be provided.
c. Nonresidents and part - year residents. – A taxpayer who is a
nonresident or part - year resident in the year to which a net operating
loss is carried over must include a schedule showing the calculation
of the amount subtracted in arriving at the numerator of the fraction
used to determine North Carolina taxable income.
5. Statute of Limitations
For both State and federal tax purposes, the period of time in which a
taxpayer may claim a refund resulting from the carryback of a net
operating loss is extended beyond the general period of limitations for
claiming a refund. The period of time for claiming a refund from the
carryback of a net operating loss expires three years after the date the
return is due, including extensions, for the year in which the loss is
incurred, not the year to which the loss is carried. For example, a calendar
year taxpayer who incurs a net operating loss in tax year 2005 and files
the 2005 return by April 15, 2006, has until April 15, 2009 to file a claim
for refund of taxes paid for the tax year 2003 because of the carryback
of the net operating loss.
6. Calculation of Interest on Overpayments
Interest accrues on an overpayment of individual income tax from a
date 45 days after the latest of the following dates: ( 1) the date the final
return is filed; ( 2) the original due of the return; or ( 3) the date of the
overpayment, until the refund is paid. An overpayment resulting from the
carryback of a net operating loss is considered to have occurred on the
date the income tax return for the year in which the loss was incurred is
filed or due to be filed, whichever is the later. Therefore, no interest
accrues on the overpayment if refunded within 45 days of the date the
tax return for the loss year is filed.
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VI. Subject: Nonresidents and Part- Year Residents
( G. S. 105- 134.5( b)( c)( d))
1. Definition of Resident
G. S. 105 - 134.1( 12) defines a resident as “ an individual who is domiciled
in this State at any time during the taxable year or who resides in this
State during the taxable year for other than a temporary or transitory
purpose.”
Domicile is the place where an individual has a true, fixed permanent
home and principal establishment, and to which place, whenever he is
absent, he has the intention of returning. There are other definitions of
domicile, and this definition is presented solely to be used as a guide in
determining residency.
If an individual lives in North Carolina for more than 183 days of a tax
year, he is presumed to be a resident for income tax purposes in the
absence of factual proof to the contrary; but the absence of an individual
from the State for more than 183 days raises no presumption that he is
not a resident.
In many cases, a determination must be made as to when or whether
a domicile has been abandoned. A long standing principle in tax
administration, repeatedly upheld by the courts, is that an individual can
have but one domicile; and, once established, it is not legally abandoned
until a new one is established. A taxpayer may have several places of
abode in a year, but at no time can an individual have more than one
domicile. A mere intent or desire to make a change in domicile is not
enough; voluntary and positive action must be taken.
Listed below are some of the tests or factors to be considered in
determining the legal residence of an individual for income tax purposes.
Some factors are more important than others, and fulfilling a few does
not necessarily mean a change in domicile has occurred. As implied by
the list of factors below, an individual’s legal state of residence is reflected
more by the routine events of life rather than events such as voting or
obtaining a driver’s license which may occur every four or five years.
a. Place of birth of the taxpayer, the taxpayer’s spouse, and the
taxpayer’s children.
b. Permanent residence of the taxpayer’s parents.
c. Family connections and close friends.
d. Address used for federal tax returns, military purposes,
passports, driver’s license, vehicle registrations, insurance
policies, professional licenses or certificates, subscriptions for
newspapers, magazines, and other publications, and
monthly statements for credit cards, utilities, bank
accounts, loans, insurance, or any other bill or item that
requires a response.
e. Civic ties, such as church membership, club membership, or
lodge membership.
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f. Professional ties, such as licensure by a licensing agency or
membership in a business association.
g. Payment of state income taxes.
h. Place of employment or, if self - employed, place where
business is conducted.
i. Location of healthcare providers, such as doctors, dentists,
veterinarians, and pharmacists.
j. Voter registration and ballots cast, whether in person or by
absentee ballot.
k. Occasional visits or spending one’s leave “ at home” if a
member of the armed services.
l. Ownership of a home, insuring a home as a primary
residence, or deferring gain on the sale of a home as a
primary residence.
m. Location of pets.
n. Attendance of the taxpayer or the taxpayer’s children at State
supported colleges or universities on a basis of residence –
taking advantage of lower tuition fees.
o. Location of activities for everyday “ hometown” living, such as
grocery shopping, haircuts, video rentals, dry cleaning, fueling
vehicles, and automated banking transactions.
p. Utility usage, including electricity, gas, telecommunications,
and cable television.
Listed below are some of the events indicating when residency may
have changed:
1. Selling a house and buying a new one.
2. Directing U. S. Postal Service to forward mail to a new address.
3. Transferring family medical records to a new health care provider.
4. Notifying senders of statements, bills, subscriptions, and similar
items of new address.
5. Registering a vehicle in a new jurisdiction.
6. Transferring memberships for church, health club, lodge, or similar
activity.
7. Applying for professional certifications in a jurisdiction.
A legal resident of North Carolina serving in the United States Armed
Forces is liable for North Carolina income tax and North Carolina income
tax should be withheld from his military pay whether he is stationed in
this State or in some other state or country.
An individual who enters military service while a resident of North
Carolina is presumed to be a resident of this State for income tax purposes.
Residency in this State is not abandoned until a definite residence is
established elsewhere.
To change residency, the serviceman must not only be present in the
new location with the intention of making it his domicile, but must also
factually establish that he has done so.
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2. Nonresidents
The term “ nonresident” includes an individual:
a. Who resides in North Carolina for a temporary or transitory purpose
and is, in fact, a domiciliary resident of another state or
country; or
b. Who does not reside in North Carolina but has income from sources
within North Carolina and is, in fact, a domiciliary resident of
another state or country.
Under the Servicemembers Civil Relief Act, a member of the Armed
Services who is a legal resident of another state stationed in North
Carolina by virtue of military orders, is not subject to North Carolina
income tax on service pay but other income from employment, a business, or
tangible property in North Carolina is subject to North Carolina income
tax.
There is no presumption as to the residence of a spouse of a member
of the armed forces because of marriage. Legal residence will be
determined based on the facts in each case.
3. Part- Year Residents
An individual who moves his domicile ( legal residence) into or out of
North Carolina during the tax year, is a part - year resident.
4. Taxable Income of Nonresidents and Part- Year Residents
Nonresidents and part - year residents are required to prorate their
federal taxable income to determine the portion that is subject to North
Carolina tax.
The taxable income of a nonresident subject to North Carolina income
tax is determined by multiplying federal taxable income as calculated
under the Internal Revenue Code, as adjusted, by the percentage obtained
when dividing the portion of total federal gross income, as adjusted, derived
from North Carolina sources, by the total federal gross income, as adjusted.
The taxable income of a part - year resident subject to North Carolina
tax is determined by multiplying the total federal taxable income as
calculated under the Internal Revenue Code, as adjusted, by the
percentage obtained when dividing the portion of total federal gross income
received from all sources during the period the individual was a resident
of North Carolina, plus any gross income received from North Carolina
sources while a nonresident, by the total federal gross income, as adjusted.
An individual who files a joint federal income tax return but cannot
qualify to file a joint North Carolina income tax return because the
individual’s spouse is a nonresident and had no North Carolina taxable
income must calculate federal taxable income on a federal income tax
form as a married person filing a separate federal income tax return and
attach it to the North Carolina return to show how the separate federal
taxable income was determined. The separate federal return should reflect
only the individual’s income, exemptions, and deductions. In lieu of making
34
the calculation on a federal form, an individual may submit a schedule
showing the computation of the separate federal taxable income. In this
case, the individual must attach a copy of the joint federal return unless
the federal return reflects a North Carolina address.
If an individual has income from sources within another state or country
while a resident of North Carolina and the other state or country taxes
the individual on such income, the individual may be eligible to claim a
tax credit on the North Carolina income tax return.
A nonresident is not entitled to the tax credit for tax paid to another
state or country.
5. Nonresident Members of Professional Athletic Teams
The North Carolina source income of a nonresident individual who is a
member of a professional athletic team is determined by multiplying the
individual’s total compensation for services rendered as a member of a
professional athletic team during the taxable year by a fraction, the
numerator of which is the number of duty days spent in North Carolina
rendering services for the team in any manner during the taxable year.
The denominator is the total number of duty days spent both within and
without North Carolina during the taxable year.
Travel days that do not involve either a game, practice, team meeting,
promotional caravan or other similar team event are not considered duty
days spent in North Carolina. However, such travel days are considered
duty days spent within and without North Carolina.
In determining the North Carolina source income of a nonresident
member of a professional athletic team, the following definitions apply:
a. The term “ professional athletic team” includes, but is not limited
to, any professional baseball, basketball, football, soccer or hockey
team.
b. The term “ member of a professional athletic team” includes those
employees who are active players, players on the disabled list and
any other persons required to travel and who do travel with and
perform services on behalf of a professional athletic team on a
regular basis. This includes, but is not limited to, coaches, managers
and trainers.
c. The term “ duty days” means all days during the taxable year from
the beginning of the professional athletic team’s official preseason
training period through the last game in which the team competes
or is scheduled to compete.
Duty days also include days on which a member of a professional
athletic team renders a service for a team on a date which does
not fall within the aforementioned period. Such services include
participation in instructional leagues, the “ Pro Bowl” or promotional
caravans. This includes days during the member’s off - season where
the member conducts training activities at the facilities of the team.
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Duty days include game days, practice days, days spent at team
meetings, promotional caravans and preseason training camps, and
days served with the team through all post - season games in which
the team competes or is scheduled to compete.
Duty days for any person who joins a team during the season
begins on the day the person joins the team, and for any person
who leaves a team ends on the day the person leaves the team.
Where a person switches teams during the taxable year, a separate
duty day calculation will be made for the period the person was
with each team.
Days for which a member of a professional athletic team is not
compensated and is not rendering services for the team in any
manner, including days when the person has been suspended
without pay and prohibited from performing any services for the
team, are not treated as duty days.
Days for which a player is on the disabled list are presumed not to
be duty days spent in North Carolina. However, such days are
considered to be included in total duty days spent within and without
North Carolina.
d. The term “ total compensation for services rendered as a member
of a professional athletic team” means the total compensation
received during the taxable year for services rendered:
( 1) from the beginning of the official preseason training period
through the last game in which the team competes or is
scheduled to compete during that taxable year; and
( 2) for an event during the taxable year which occurs on a date
which does not fall within the aforementioned period such
as participation in instructional leagues, the “ Pro Bowl” or
promotional “ caravans.”
Such compensation includes, but is not limited to, salaries, wages,
bonuses, and any other type of compensation paid during the taxable
year for services performed in that year. Such compensation does
not include strike benefits, severance pay, termination pay, contract
or option year buy - out payments, expansion or relocation payments,
or any other payments not related to services rendered to the
team.
e. “ Bonuses” are included in “ total compensation for services
rendered as a member of a professional athletic team” and subject
to allocation if they are:
( 1) earned as a result of play, such as performance bonuses,
during the season, including bonuses paid for championship,
playoff or “ bowl” games played by a team, or for selection
to all - star league or other honorary positions; and
36
( 2) paid for signing a contract, unless all of the following
conditions are met:
a. the payment of the signing bonus is not conditional upon
the signee playing any games for the team, or performing
any subsequent services for the team, or even making the team;
b. the signing bonus is payable separately from the salary
and any other compensation; and
c. the signing bonus in nonrefundable.
Where the method for determining North Carolina source income does
not fairly and equitably apportion and allocate the compensation of a
nonresident member of a professional athletic team for services rendered
in North Carolina, the Secretary of Revenue may require the person to
apportion and allocate the compensation under another method prescribed
by the Secretary as long as the prescribed method results in a fair and
equitable apportionment and allocation. A nonresident member of a
professional athletic team may submit a proposal for an alternative method
to apportion and allocate the compensation, demonstrating that the method
provided under this section does not fairly and equitably apportion and
allocate the compensation. If approved, the proposed method must be
fully explained in the North Carolina income tax return filed by the
nonresident member.
See page 92 for the withholding requirements of professional athletic
teams.
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VII. Subject: S Corporations ( G. S. 105- 131 - G. S. 105- 131.8)
1. Reporting Income _ In General
An individual shareholder of an S corporation is required to take into
account his pro rata share of an S corporation’s net income in the manner
provided under Section 1366 of the Internal Revenue Code subject to
certain adjustments.
2. Resident Shareholders
Since 100 percent of the S corporation’s income is included in the
federal taxable income starting point, no adjustment because of doing
business outside of North Carolina is required by a resident.
3. Nonresident Shareholders
A nonresident shareholder of an S corporation takes into account only
his share of the S corporation’s income attributable to North Carolina in
the numerator of the fraction in determining that portion of federal taxable
income that is taxable to North Carolina. If an S corporation does business
in North Carolina and one or more other states, the income attributable
to North Carolina is determined by the same apportionment formula as
used for other corporations.
All nonresident shareholders must include an agreement with the first
S corporation return filed with North Carolina agreeing to be liable and
subject to the laws of North Carolina for individual income tax purposes;
otherwise, the S corporation becomes liable for the tax on the income
attributable to such nonresident shareholders at the rate for single
individuals.
A nonresident shareholder in an S corporation may claim the
proportionate share of the tax paid on his behalf by the S corporation to
North Carolina on his share of the S corporation income.
4. Tax Credits
If part of the S corporation’s income is earned within and taxed by
another state or country, either to the individual or to the corporation, a
resident shareholder is entitled to a tax credit on his individual income
tax return for his share of the tax paid to the other state or country. A
shareholder claiming the tax credit must attach a schedule to his income
tax return reflecting the total amount of tax paid to the other state or
country by the S corporation, and explaining how his pro rata share of
the tax was determined. A separate tax credit must be calculated for
each state or country to which the S corporation paid tax. Nonresident
shareholders are not allowed credit for tax paid to another state or country.
Pursuant to North Carolina General Statutes 105 - 134.6( a) and 105 -
130.5( a)( 10), an addition to federal taxable income is required on a
shareholder’s return for the amount of all tax credits claimed by the S
corporation and passed through to the individual shareholders, with the
exception of the credit for tax paid to another state or country and the
credit for donation of real property under G. S. 105 - 130.9( 4).
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Example:
S corporation claims the tax credit for creating jobs ( G. S. 105 -
129.8). The installment for the tax year 2005 is $ 1,000 and the S
corporation elects to claim this credit against the income tax rather
than the franchise tax. There are two ( 50%) shareholders. Each
shareholder claims the jobs tax credit of $ 500 on his or her indi -
vidual income tax return. Therefore, each individual taxpayer must
add to federal taxable income the tax credit of $ 500 claimed on his
or her individual income tax return.
5. Basis in Stock
Due to different tax treatment of an S corporation’s income for State
and federal purposes for taxable years beginning before January 1, 1989,
a shareholder’s basis in the stock of an S corporation for State tax
purposes may be different than for federal tax purposes; thereby requiring
transitional adjustments in determining North Carolina taxable income
upon receipt by the shareholder of distributions from the S corporation
and upon disposition of the S corporation stock.
The initial basis of the stock in an S corporation to a nonresident of
North Carolina is zero, and the nonresident shareholder is not taxed on
distributions from the corporation and recognizes no income or loss upon
disposition of the stock. A nonresident shareholder’s basis in the S
corporation stock is adjusted for his pro rata share of the income or loss
of the corporation.
A resident shareholder’s initial basis in the stock of an S corporation is
determined as of the later of the date the stock is acquired, the effective
date of the S corporation election, or the date the shareholder became a
resident of North Carolina. A resident shareholder’s basis in the stock is
increased by his pro rata share of the corporation’s income adjusted
pursuant to G. S. 105 - 131.2 except for income exempt from federal or
State income taxes and deductions for depletion in excess of the basis of
the property being depleted. The basis is decreased by distributions to
the extent deemed a return of basis; a pro rata share of the losses of the
corporation as adjusted; nondeductible expenses of the corporation; and
the amount of the shareholder’s deduction for depletion of oil and gas
wells to the extent the deduction does not exceed the proportionate share
of the adjusted basis of that property allocated to the shareholder. The
adjustments to the basis do not apply to tax periods beginning prior to
January 1, 1989.
The aggregate amount of losses taken into account by the shareholder
of an S corporation may not exceed the combined adjusted basis of the
shareholder’s stock and indebtedness of the corporation to the shareholder.
Example:
A is a resident of North Carolina and his share of the loss of an S
corporation for the tax year 1989 is $ 50,000. On January 1, 1989,
A’s basis in the S corporation stock for federal income tax purposes
was $ 110,000, comprised of $ 40,000 initial cost plus his share of
39
the undistributed income of the S corporation of $ 70,000. Since
for federal tax purposes the loss does not exceed his basis, the
$ 50,000 is allowed as a deduction in computing federal taxable
income. For State tax purposes, his basis is the $ 40,000 initial cost
since the prior year undistributed income is not included in his
basis due to being for tax years prior to January 1, 1989. Therefore,
the loss that A may take into account in determining his North
Carolina taxable income is $ 40,000 and he is required to adjust federal
taxable income by $ 10,000 ($ 50,000 total loss less $ 40,000 basis).
6. Distributions
A resident shareholder must take into account distributions from an S
corporation in computing North Carolina taxable income to the extent
the distributions are characterized as dividends or as gains pursuant to
Section 1368 of the Internal Revenue Code. Section 1368 of the Code
provides that if the S corporation has no accumulated earnings and profits,
the amount distributed to a shareholder reduces the adjusted basis in his
stock. If the distribution exceeds his basis, the excess is treated as a
capital gain. If the S corporation has earnings and profits, the distribution
is applied in the following order:
( 1) To the Accumulated Adjustments Account ( AAA) which basically
includes the income during the period the corporation has been an
S corporation reduced by its losses and distributions during that
period. The AAA for State income tax purposes does not include
the federal AAA for tax years beginning prior to January 1, 1989.
The shareholder does not take into account distributions from the
AAA in determining taxable income but such distributions reduce
the adjusted basis of his stock.
( 2) To Earnings and Profits ( E and P): An S corporation is not
considered to have earnings and profits for State tax purposes for
years in which it operates as an S corporation after January 1,
1989. The E and P account basically includes the earnings and
profits on hand from the period the corporation was a C corporation;
and for State tax purposes, the E and P account also includes the
undistributed earnings and profits of the S corporation from tax
years beginning before January 1, 1989, ( the federal AAA that
existed on the day North Carolina began to measure the S
corporation shareholder’s income by reference to the income of
the S corporation). The amount distributed to the shareholder from
the E and P account is taxed to the shareholder as a dividend.
Since the State E and P account includes the federal AAA that
existed prior to the change in State law taxing the S corporation
income to the shareholders, federal taxable income must be
increased for any distributions from the federal AAA that existed
prior to the law change.
( 3) To the basis of the shareholder’s stock. Any excess over the
shareholder’s basis is taxed as a capital gain.
40
A shareholder who makes an election for federal tax purposes to treat
distributions from the S corporation as being paid first from earnings and
profits may not make a different election for State purposes.
The following examples illustrate transitional adjustments required in
determining North Carolina taxable income of a shareholder from
distributions of S corporations:
( 1) A North Carolina corporation chartered on January 1, 1986, elected
to be taxed as an S corporation for federal income tax purposes.
Taxpayer A invested $ 100,000 in the corporation; and at the end
of the tax year 1988, A’s pro rata share of the S corporation’s
accumulated adjustments account for federal income tax purposes
was $ 50,000. A’s pro rata share of the S corporation’s net income
for the tax year 1989 was $ 20,000. The S corporation distributed
$ 100,000 to A during the tax year 1989. In this case, A would
include his $ 20,000 share of the S corporation’s net income in his
federal taxable income. For federal income tax purposes, A would
not be taxed on any part of the $ 100,000 distribution since it is
considered to have been paid from his accumulated adjustments
account and reduces the basis of his stock.
Original investment .................................................... $ 100,000
Accumulated adjustments account at the end of 1989
($ 50,000 plus $ 20,000) .......................................... 70,000
Adjusted basis of stock at end of year ...................... $ 170,000
Less: Distribution ....................................................... 100,000
Adjusted basis of stock as of January 1, 1990 .......... $ 70,000
For State income tax purposes, the $ 50,000 accumulated adjustments
account balance on December 31, 1988, is treated as additional earnings
and profits and A’s federal taxable income must be increased for any
part of the distribution attributable to earnings and profits in determining
North Carolina taxable income. The amount is determined as follows:
Investment in the corporation ................................... $ 100,000
Pro rata share of 1989 earnings —
accumulated adjustments account ......................... 20,000
Adjusted basis in stock at end of tax year ................ $ 120,000
Distributions .............................................. $ 100,000
Applied to accumulated adjustments
account .................................................. ( 20,000) ( 20,000)
Balance of distribution .............................. $ 80,000
Earnings and profits .................................. ( 50,000)
Balance of distribution .............................. $ 30,000 ( 30,000)
Basis in stock as of January 1, 1990 ........................ $ 70,000
41
The $ 50,000 from earnings and profits is a transitional adjustment and
represents a dividend to the shareholder.
( 2) Shareholders of a North Carolina C corporation elect to be taxed
as an S corporation effective for the tax year beginning January 1,
1989. Taxpayer B, a resident of North Carolina, owned 4,000 shares
of the corporate stock with a basis of $ 500,000 at the time of the
election. At that time, B’s pro rata share of the C corporation’s
undistributed earnings and profits was $ 800,000. During the tax
year 1989, his pro rata share of the S corporation’s earnings was
$ 50,000 and the corporation distributed $ 1,000,000 to B in 1989. In
this case, B would include in federal taxable income his $ 50,000
pro rata share of the S corporation’s net income and dividends of
$ 800,000 representing his share of the undistributed earnings and
profits accumulated during the period the corporation operated as
a C corporation. His basis in the corporate stock for federal tax
purposes would be reduced to $ 350,000 determined as follows:
Cost of stock ............................................................. $ 500,000
1989 earnings — added to accumulated
adjustments account .............................................. 50,000
Basis before deductions ............................................ $ 550,000
Distributions ........................................ $ 1,000,000
Applied to accumulated adjustments
account ............................................ ( 50,000) ( 50,000)
Balance ............................................... $ 950,000
Applied to earnings and profits ........... ( 800,000)
Balance of distribution ........................ $ 150,000 ( 150,000)
Basis in stock as adjusted as
of January 1, 1990 ................................................. $ 350,000
No adjustment would be necessary in determining North Carolina
taxable income since the State and federal accumulated adjustment
account and the accumulated earnings and profit account are the same.
( 3) Shareholders of a North Carolina C corporation elected to be taxed
as an S corporation for federal income tax purposes effective
January 1, 1986. At that time, taxpayer X owned 200 shares of the
stock with a cost basis of $ 50,000. X’s pro rata share of the C
corporation’s undistributed earnings and profits on January 1, 1986,
was $ 20,000. His pro rata share of the earnings of the S corporation
was $ 10,000; $ 5,000; ($ 10,000); and $ 15,000, respectively, for the
tax years 1986, 1987, 1988 and 1989. No distributions were made
to X in the tax years 1986 and 1988. Distributions were made to X
of $ 10,000 in 1987 and $ 35,000 in 1989. In this case, X must include
his pro rata share of the 1989 earnings of $ 15,000 in his 1989
42
federal taxable income. The part of the $ 35,000 distribution that is
included in federal taxable income as a dividend is determined as
follows:
Distributions in 1989................................................... $ 35,000
Accumulated adjustments account —
1986 share of income ............................ $ 10,000
1987 share of income ............................ 5,000
1987 distribution ..................................... ( 10,000)
1988 share of income ( loss) ................... ( 10,000)
Balance as of 12/ 31/ 88 .......................... ( 5,000)
1989 share of income ............................ 15,000
Total ....................................................................... 10,000
Balance of distribution .............................................. $ 25,000
Applied to undistributed earnings while a
C corporation ( dividend) ........................................ 20,000
Excess distribution applied to reduce basis ............... $ 5,000
For federal tax purposes, X must include the $ 20,000 distribution of
earnings and profits in his federal taxable income as dividends. The
adjustment required in computing his North Carolina taxable income is
determined as follows:
Distributions in 1989.................................................. $ 35,000
Applied to accumulated adjustments account —
( 1989 share of income) .......................................... 15,000
Balance of distribution .............................................. $ 20,000
Undistributed earnings and profits:
Balance January 1, 1986 ........................... $ 20,000
Federal accumulated adjustments
account as of December 31, 1988 ......... ( 5,000)
Earnings and profits as adjusted
for State tax purposes ( treated
as dividend) ............................................ 15,000 ( 15,000)
Excess distribution applied to
reduce basis ........................................................... $ 5,000
X would be entitled to deduct $ 5,000 ($ 20,000 less $ 15,000) from his
federal taxable income as a transitional adjustment in computing his North
Carolina taxable income.
43
7. Losses
The amount of loss a shareholder may deduct is limited to the adjusted
basis of the shareholder’s stock, plus the adjusted basis of any loans
owed to the shareholder by the corporation. The amount of the loss for
the taxable period is figured before the shareholder’s basis in the stock
is adjusted for any distributions during the tax year. If the amount of the
loss of a shareholder is limited because it exceeds the adjusted basis, the
excess is treated as incurred by the corporation in the next tax year.
8. Foreign S Corporations
North Carolina income tax is required to be withheld from compensation
paid to foreign S corporations for certain personal services performed in
North Carolina. ( See XVI. Withholding From Nonresidents for
Certain Personal Services.) If the S corporation has obtained a
certificate of authority from the Secretary of State, no tax is required to
be withheld if the S corporation provides to the payer the S corporation’s
corporate identification number issued by the Secretary of State.
S Corporations may claim credit on the S corporation franchise and
income tax return, Form CD - 401S, for the portion of the tax withheld
attributable to shareholders on whose behalf the corporation files a
composite return. The portion of the tax withheld attributable to
shareholders who are not part of a composite return must be allocated to
those shareholders on Schedule K of the S corporation return.
44
VIII. Subject: Estates and Trusts ( G. S. 105- 160 - G. S. 105- 160.8)
1. General
All income of an estate or trust is taxed to the fiduciary or the beneficiary.
The conduit rules for taxing estates and trusts are applicable for North
Carolina income tax purposes. Under the conduit rules, regardless of
who is taxed, the income retains its same character as when received by
the estate or trust.
A trust is neither a resident nor a nonresident. A trust’s North Carolina
income tax liability is determined based, in part, on the situs of the income
beneficiaries, not where the trust was established or where the trustee
lives. North Carolina law requires the tax to be computed on the taxable
income of the estate or trust that is for the benefit of a resident of this
State, or for the benefit of a nonresident to the extent that the income ( 1)
is derived from North Carolina sources and is attributable to the ownership
of any interest in real or tangible personal property in this State or ( 2) is
derived from a business, trade, profession, or occupation carried on in
this State.
2. Estates and Trusts Returns
The federal taxable income of the fiduciary is the starting point for
preparing a North Carolina Income Tax Return for Estates and Trusts,
Form D - 407 and requires the same additions, deductions, and transitional
adjustments to federal taxable income as required for individuals.
The fiduciary responsible for administering the estate or trust is
responsible for filing the return and paying the tax. The fiduciary must
file an income tax return for the estate or trust for which he acts if he is
required to file a federal return for estates and trusts and ( 1) the estate
or trust derives income from North Carolina sources or ( 2) the estate or
trust derives any income which is for the benefit of a resident of North
Carolina. Exception: With respect to grantor trust returns, North
Carolina has access to the federal information contained in the federal
grantor trust returns. Therefore, a State grantor trust return is not required
to be filed when the entire trust is treated as a grantor trust for federal
tax purposes.
The return is required to be filed on or before April 15 if on a calendar
year basis and on or before the 15th day of the fourth month following
the end of the fiscal year if on a fiscal year basis. If the return cannot be
filed by the due date, the fiduciary may apply for an automatic six month
extension of time to file the return. To receive the extension, the fiduciary
must file Form D - 410P, Application for Extension for Filing Partnership,
Estate, or Trust Return, by the original due date of the return.
3. Payment of Tax
The tax rate for estates and trusts is the same as the tax rates for
single individuals. ( See the Tax Rate Schedule on page 5.)
The tax due on the estate and trust return is payable in full by the due
date of the return.
45
4. Penalties
The penalty for failure to file an estate or trust return by the due date
is 5 percent of the tax per month with a minimum of $ 5.00 and a maximum
of 25 percent of the tax.
The penalty for failure to pay the tax by the due date is 10 percent of
the tax with a minimum penalty of $ 5.00.
Other penalties for fraud, negligence, and criminal penalties for willful
failure to comply with the income tax laws are similar to those applicable
to individuals.
5. Allocation of Adjustments
The additions and deductions to federal taxable income of an estate or
trust must be apportioned between the estate or trust and the beneficiaries
based on the distributions of income made during the taxable year. Unless
the trust instrument or will that created the estate or trust specifically
provides for the distribution of certain classes of income to different
beneficiaries, the apportionment of additions and deductions to the
beneficiaries is determined on the basis that each beneficiary’s share of
the income for regular tax purposes from Schedule K - 1, Federal Form
1041 relates to adjusted total income from Federal Form 1041. If the
trust instrument or will specifically provides for the distribution of certain
classes of income to different beneficiaries, any addition or deduction
directly attributable to a particular class of income must be apportioned
to the beneficiary to which that class of income is distributed. In allocating
the adjustments, for State purposes the amount of income for regular tax
purposes on Federal Schedule K - 1 must be adjusted for distributions to
the beneficiary which are not reflected in income for regular tax purposes.
The adjusted total income on Federal Form 1041 must be adjusted ( 1) to
exclude classes of income that are not part of the distribution to the
beneficiary; ( 2) to include classes of income that are a part of the
distribution to the beneficiary which are not included in adjusted total
income; and ( 3) by any deduction treated differently for State and federal
tax purposes that adjust federal taxable income pursuant to G. S. 105 -
134.6 and G. S. 105 - 134.7. After apportioning the additions and deductions
to the beneficiaries, the balance is apportioned to the fiduciary.
6. Allocation of Income Attributable to Nonresidents
If the estate or trust has income from sources outside of North Carolina
and if any of the beneficiaries are nonresidents of North Carolina, the
portion of federal taxable income of the fiduciary that is subject to North
Carolina tax must be determined. If there is no gross income from
dividends, interest, other intangibles or from sources outside North
Carolina for the benefit of a nonresident beneficiary, the total income of
the estate or trust is taxable to the fiduciary.
The determination of the amount of undistributed income from intangible
property which is for the benefit of a resident is based on the beneficiary’s
state of residence on the last day of the taxable year of the trust. In the
46
case of both resident and nonresident beneficiaries, the determination of
the amount of undistributed income from intangible property which is for
the benefit of a resident is made on the basis that the resident beneficiary’s
interest for the taxable year relates to the interest of both resident and
nonresident income beneficiaries for the taxable year.
7. Tax Credits
Estates and trusts are allowed all tax credits allowed to individuals
except for:
a. Tax credit for income taxes paid by individuals to other states or
countries,
b. Tax credit for child and dependent care,
c. Tax credit for the disabled,
d. Tax credit for children, and
e. Tax credit for charitable contributions by nonitemizers
Form D - 407TC is used to report any tax credits claimed on an estate
or trust return. The amounts reflected on Form D - 407TC are the portions
of the tax credits allocated to the trust or estate. A fiduciary required to
pay an income tax to North Carolina for a trust for which he acts may
claim a credit for tax imposed and paid to another state or country on
income from sources within that state or country under the provisions of
G. S. 105 - 160.4( a).
A resident beneficiary of an estate or trust, the fiduciary of which
pays an income tax to another state or country on distributable income
reportable to North Carolina which is derived from sources in the other
state or country may claim a credit against his North Carolina income
tax for his share of tax paid the other state or country under the provisions
of G. S. 105 - 160.4( e).
Part 5 of Form D - 407TC is to be used in computing the tax credit
allowable to the estate or trust. Before this schedule may be completed
however, there must be an allocation between the estate or trust and its
beneficiaries of the tax paid and the gross income on which such tax
was paid to the other state or country.
The fiduciary’s share and each beneficiary’s share of the gross income
on which tax has been paid to another state or country is determined by
the governing instrument and should be entered in the appropriate schedule
on the return. The fiduciary’s share of total gross income to be used in
the tax credit computation schedule is the total gross income from Federal
Form 1041.
47
IX. Subject: Partnerships ( G. S. 105- 154)
1. General
The partnership���s taxable income determined under the Internal
Revenue Code is the starting point for preparing the North Carolina
partnership income tax returns. The same additions, deductions, and
transitional adjustments to federal taxable income required for individuals
apply to partnerships.
2. Partnership Returns
A North Carolina partnership return ( Form D - 403), must be filed by
every partnership doing business in North Carolina if a federal partnership
return was required to be filed. The return of a partnership on a calendar
year basis is due on or before April 15 following the close of the calendar
year. If on a fiscal year basis, the return must be filed on or before the
15th day of the fourth month following the close of the fiscal year. If the
partnership return cannot be filed by the due date, the partnership may
apply for an automatic six month extension of time to file the return. To
receive the extension, the partnership must file Form D - 410P, Application
for Extension for Filing Partnership, Estate, or Trust Tax Return, by the
original due date of the return.
The return should include the names and addresses of the individuals
entitled to share in the net income of the partnership and should be signed
by the managing partner and the individual preparing the return. For
individual income tax purposes, the term “ business carried on in this
State” means the operation of any activity within North Carolina regularly,
continuously, and systematically for the purpose of income or profit. A
sporadic activity, a hobby, or an amusement diversion does not come
within the definition of a business operation in this State. Income from
an intangible source which is received in the course of a business operation
in this State so as to have a taxable situ

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State of North Carolina
INDIVIDUAL INCOME TAX
GIFT TAX
ESTATE TAX
RULES AND BULLETINS
TAXABLE YEARS
2005 and 2006
Issued by:
Personal Taxes Division
Tax Administration
North Carolina Department of Revenue
501 North Wilmington Street
Raleigh, North Carolina 27604
PREFACE
This publication was prepared for the purpose of presenting the
administrative interpretation and application of North Carolina income
tax laws relating to individuals, partnerships, estates, trusts, and gifts in
effect at the time of publication for income years beginning on and after
January 1, 2005. This publication does not cover all provisions of the
law.
Taxpayers are cautioned that this publication is intended merely as a
guide and that consideration must be given to all the facts and
circumstances in applying these bulletins to particular situations.
Taxpayers using this publication should be aware that additional changes
may result from legislative action, court decisions, and rules adopted or
amended under the Administrative Procedure Act, Chapter 150B of the
General Statutes. In no case should these bulletins be relied upon for
years other than the taxable years 2005 and 2006.
Revised December 2005
TAXPAYERS’ BILL OF RIGHTS
The North Carolina Taxpayers’ Bill of Rights explains
your rights as a taxpayer.
This Bill of Rights is designed to provide you with information about:
• Protection of Privacy
• Examination of Returns
• Hearing & Appeals Process
• Revenue Collection Process
• Refund of Overpaid Tax
• Penalties & Interest
As a taxpayer, you are always entitled to fair, professional, prompt and courteous service. Our goal is to
apply the tax laws consistently and fairly so that your rights are protected and to see that you pay only your
fair share of North Carolina tax.
Protection of Privacy — It is your right to have information about your tax history, financial situation,
assessments or reviews kept in strict confidence. Any return information, correspondence, or departmental
discussions concerning your tax situation will be completely confidential. Employees or former employees
who violate this confidentiality are subject to criminal prosecution which may result in dismissal plus fines.
Examinations — The Department of Revenue routinely examines returns to ensure that taxpayers comply with
tax statutes. If we examine your return, we may ask you to provide information to verify figures on your return.
Examinations are done by mail or through personal interviews with auditors. You have the right to ask that
the examination be held at a time and place convenient for you and the auditor.
You are entitled to a fair examination and an explanation of any changes we propose to your return. Exami -
nations do not necessarily mean additional taxes. Your case could be closed without any changes or you
could receive a refund.
Representation — During any examination, review, or hearing, you may have an attorney, accountant, or
designated agent present. You can authorize another person to represent you if you execute a written power
of attorney. If you wish, the Department will suspend the proceedings at any time to permit you to consult with
your authorized representative.
You may make an audio recording of the proceedings at your own expense with your own equipment. The Department
may also audio record the proceedings. If we do so, you can get a copy of the transcript for a nominal charge.
Appeals — You have the right to appeal the actions of the Department of Revenue if you do not agree with
a proposed assessment or reduced refund. To appeal a tax notice, you must file a written request, either for a
hearing or for a written statement of the information on which the notice is based. The request must be mailed
to the Department within 30 days from the date the notice was mailed to you. If you request a written statement
about your notice, you will receive it within 45 days. You then have 30 days from the date the statement was
mailed to file a written request for a hearing.
Hearings — The Secretary of Revenue will notify you of the time and place of an administrative tax hearing
within 60 days after you request one and at least 10 days before the date set for the hearing. The hearing will
be scheduled within 90 days of your request or at a later date mutually agreed upon by you and the Department.
The date set for the hearing may be postponed once at your request and once at the Secretary’s request.
All parties attending a hearing may present information and ask questions. Written decisions are mailed
to taxpayers following hearings.
If you disagree with the findings of your hearing, you may:
• Petition the Tax Review Board for administrative review of the decision, or
• Pay the tax and sue to recover the amount paid.
To have an administrative review, you must file a notice of intent to petition for review with the Tax Review
Board within 30 days of the hearing decision.
After filing the “ notice of intent”, you must file a written statement or “ petition” within 90 days of the
hearing decision explaining your objections to the decision.
If the Tax Review Board upholds the decision of the Secretary of Revenue, you have the right to appeal to
the Superior court. ( The appeal information is a general description of your appeals rights and does not
cover all situations)
Collections — If the proposed assessment is upheld upon the conclusion of the appeals process, the
assessment becomes final and collectible.
You are responsible for the full amount of tax you owe, but we will not take action to collect from you until you
have had an opportunity to pay voluntarily. It is important that you respond promptly if we contact you for
payment. If you do not pay the amount of tax, penalty, and interest you owe within 90 days after a final notice of
assessment was mailed to you, the law requires the Department to add a 20% collection assistance fee to your debt.
The fee does not apply if you enter into an installment payment agreement with the Department before the fee is
imposed.
If you do not pay, the Department of Revenue may garnish your wages, bank account or other funds, issue
a tax warrant to your sheriff, or record a certificate of tax liability against you.
If we believe that you owe tax and collecting that tax is in jeopardy, the Department can immediately assess
and collect the tax. You are entitled to an administrative tax hearing on the jeopardy assessment. If you
disagree with the findings of the hearing, you have the right to bring civil action in Superior Court.
Refund of Overpaid Tax — If you believe you have overpaid your taxes, you have the right to file a claim for refund.
Generally, you can apply for a refund of tax paid at any time within three years after the due date of the return
or within six months of paying the tax, whichever is later.
If we select your claim for examination, you have the same rights you would have during an examination
of your return.
Penalties & Interest — By law, the Department of Revenue is required to assess penalties for the following.
• Late Filing of Returns • Fraud
• Late Payment of Tax • Bad Checks/ EFT Payments
• Negligence
You have the right to request that penalties be waived. The Department waives penalties in accordance
with its Penalty Waiver Policy.
Interest accrues on unpaid taxes from the date the tax was due until the date it is paid. Interest is also
applicable to the underpayment of estimated income tax. The law does not permit the Department to waive
interest which accrues on unpaid taxes.
CONTENTS
I. Filing Individual Income Tax Returns ........................ 1
II. Filing Requirements ................................................. 6
III. Computation of Taxable Income ............................. 10
IV. Bailey Settlement ................................................... 23
V. Net Operating Losses ............................................. 28
VI. Nonresidents and Part - year Residents .................... 31
VII. S Corporations ....................................................... 37
VIII. Estates and Trusts ................................................... 44
IX. Partnerships ........................................................... 47
X. Taxable Status of Distributions from
Regulated Investment Companies ....................... 52
XI. Tax Credits ............................................................. 54
XII. Statute of Limitations and Federal Changes ............ 68
XIII. Penalties, Interest, and Required Filing of
Information Returns ............................................ 72
XIV. Miscellaneous Rules .............................................. 74
XV. Withholding from Pensions, Annuities
and Deferred Compensation ................................... 78
XVI. Withholding from Nonresidents for Certain
Personal Services ............................................... 82
XVII. Withholding of Income Tax..................................... 88
XVIII. Reporting and Paying Tax Withheld ........................ 96
XlX. Estimated Income Tax ............................................. 99
XX. Interest on Underpayment of
Estimated Income Tax ....................................... 101
XXI. Gift Tax ................................................................ 104
XXII. Estate Tax ............................................................. 109
Index..................................................................... 112
IMPORTANT TOLL FREE TELEPHONE NUMBERS
TAXPAYER ASSISTANCE AND FORMS 1- 877- 252- 3052
AUTOMATED REFUND INQUIRY LINE 1- 877- 252- 4052
( Available 24 hours a
day, 7 days a week)
FREQUENTLY ASKED QUESTIONS 1- 877- 252- 3052
INTERNAL REVENUE SERVICE 1- 800- 829- 1040
( Toll free within
North Carolina)
TAX FRAUD HOTLINE 1- 800- 232- 4939
( 733 - 6354 in Wake
County) Toll free from
8: 00 a. m. to 5: 00
p. m., Monday through
Friday, except
holidays.)
DEPARTMENT OF REVENUE WEBSITE
www. dornc. com
1
I. Subject: Filing Individual Income Tax Returns
1. Forms
The individual income tax return, Form D - 400, is available from the
Department of Revenue in Raleigh or from any of the Department’s
Service Centers located throughout the State. The return and other related
schedules are also avaliable from the Department’s website at
www. dornc. com.
2. Electronic Tax Filing
The North Carolina Department of Revenue participates in the Federal/
State e- file program. This program allows residents, nonresidents, and
part - year residents to file their federal and State individual income tax
returns in a single electronic transmission or file their State return
separately. E- file is the fastest, safest, and most accurate way to file
income tax returns. Taxpayers who e- file can have their refunds direct
deposited into a checking or savings account. E- file is offered by a
rapidly growing number of tax practitioners. A list of tax practitioners
that offer electronic filing is on the Department’s website,
www. dornc. com. The State return can be a refund, zero tax due, or
balance due return.
To participate in the Federal/ State e- file Program, a tax practitioner
must complete IRS Form 8633, Application to Participate in the E- file
Program, and submit it to the IRS. The practitioner must have been
accepted into the program and received an Electronic Filing Identification
Number ( EFIN) in order to participate in State e- file. The Department
will have access to the Federal Applicant Database that enables the
Department to reference pertinent information regarding the tax
practitioner. The tax practitioner must use computer software that has
been approved by the IRS and the Department of Revenue for filing.
The Department of Revenue maintains a list of approved software
developers on its website.
The Department of Revenue also participates in the Federal/ State
Online Filing Program. A taxpayer with a personal computer and modem
can file their federal and State returns in one transmission or the State
return separately. A taxpayer must use approved online software to e- file
the federal and State returns. A list of approved online software products
is on the Department’s website.
3. Items Requiring Special Attention
The individual taxpayer or his agent should give special attention to the
following items when preparing an individual income tax return:
a. The Form D - 400 for the proper year should be used. For example,
a 2005 form should be used by a taxpayer whose calendar year
ends December 31, 2005. A taxpayer filing on a fiscal year basis
whose fiscal year begins in 2005 should also use a 2005 form.
2
b. The first name, middle initial, last name and the current mailing
address of the taxpayer ( taxpayers; if joint) should be printed in
the applicable boxes on the tax return. Do not use the name or
address shown on a wage and tax statement if incorrect. Enter
the social security number( s) in the applicable boxes.
c. When filing an income tax return for an unmarried individual who died
during the taxable year, enter the date of death in the applicable box.
d. When filing a separate return of a decedent who was married at
the time of death, enter the date of death in the applicable box and
enter the address of the surviving spouse or personal representative.
e. The taxpayer is required to furnish his social security number with
the return. This number is necessary to verify the identity of the
taxpayer, since the Department identifies taxpayers and credits
refunds and payments by social security number.
Separate returns of spouses are often interrelated whether they
are living together or apart; therefore, the taxpayer is asked to
furnish the name and social security number of the spouse if they
file on separate forms, but not if they are divorced. This information
can save time, correspondence, and difficulty for the taxpayer
and the Department.
f. The same filing status claimed on the federal income tax return
must also be claimed on the North Carolina income tax return.
However, if either the taxpayer or the taxpayer’s spouse is a
nonresident and had no North Carolina taxable income for the taxable
year, the filing status Married Filing Separately must be claimed.
g. The tax must be computed accurately and any penalty and interest
prescribed by statute should be included on the return.
h. If additional tax is due on the income tax return, it can be paid by
check or money order with the return, or it can be paid online by
bank draft or credit or debit card using Visa or MasterCard. Note:
The Department will not accept a check, money order, or cashier’s
check unless it is drawn on a U. S. ( domestic) bank and the funds
are payable in U. S. dollars.
i. If an individual has moved into or out of North Carolina during the
tax year or is a nonresident with income from sources within North
Carolina, the section on page 4 of Form D - 400, “ Computation of
North Carolina Taxable Income for Part - Year Residents and
Nonresidents” must be completed. Credit for tax paid to another
state is not allowed to an individual moving into or out of this state
unless the individual has income derived from and taxed by another
state or country while a resident of this State. ( See Credit for Tax
Paid to Another State or Country on page 54.)
j. If a tax credit is claimed for tax paid to another state or country,
there must be attached to the return a true copy of the return filed
3
with the other state or country and a cancelled check, receipt, or
other proof of payment of tax.
k. Every return must be signed and dated by the taxpayer or the
taxpayer’s authorized agent, and joint returns should be signed and dated
by both spouses. A refund may be delayed by an unsigned return.
l. Where tax has been withheld, the original or copy of the original
State wage and tax statement that was received from an employer
must be attached to the return. Wage and tax statements or 1099
statements generated by tax software programs cannot be used
to verify North Carolina tax withheld.
m. Any additional information that will assist in the processing and
auditing of a return should be attached to the return.
n. Anyone who is paid to prepare a return must sign and date the return
in the space provided. When more than one person prepares a return,
the preparer with primary responsibility for the overall accuracy of
the return must sign as the preparer. The preparer must manually sign
and date the prepared return. Preparers may use the practitioner ID
number ( PTIN) in lieu of their social security number. Preparers
should also include their phone numbers in the space provided.
4. Substitute Returns
Any facsimile or substitute form must be approved by the Department
of Revenue prior to its use. The guidelines for producing substitute
forms are available in the publication, “ Requirements for the Approval
of Substitute Tax Forms.” The publication is available on the
Department’s Website, or it can be obtained by contacting the
Department’s forms coordinator. If you use computer generated returns,
the software company is responsible for requesting and receiving an
assigned barcode. The Department publishes a list of software developers
who have received approval on it’s website. Photocopies of the return
are not acceptable. Returns that cannot be processed by the
Department’s imaging and scanning equipment may be returned to the
taxpayer with instructions to refile on an acceptable form.
5. Federal Forms
Taxpayers must include a copy of their federal return with the North
Carolina return unless their federal return reflects a North Carolina address.
6. Extensions
If an income tax return cannot be filed by the due date, an individual
may apply for an automatic six - month extension of time to file the return.
To receive the extension, an individual must file Form D - 410, Application
for Extension for Filing Individual Income Tax Return, by the original
due date of the return. A copy of the individual’s federal extension is
not acceptable. Partnerships, estates, or trusts must file Form D - 410P,
Application for Extension for Filing Partnership, Estate, or Trust Tax
Return, to apply for an extension of time to file a return.
4
Although a taxpayer is not required to send a payment of the tax
estimated to be due, it will benefit the taxpayer to pay as much as possible
with the extension request. An extension of time for filing the return
does not extend the time for paying the tax. If the tax due is not paid by
the original due date, interest will be due on the unpaid amount. The 10
percent late payment penalty will not be due if the taxpayer pays at least
90 percent of the tax liability through withholding, estimated tax payments,
or with Form D - 410 by the original due date.
A late filing penalty may be assessed if the return is filed after the due
date ( including extensions). The penalty is 5 percent per month ($ 5
minimum; 25 percent maximum) on the remaining tax due.
If the application for extension is not filed by the original due date of
the return, the taxpayer is subject to both a late filing penalty and a late
payment penalty. The penalties will also apply if the extension is not valid.
An application for extension is considered invalid if the amount entered on
the extension form as the tax expected to be due is not properly estimated.
In determining whether the amount reflected as tax due on the application is
properly estimated, all facts and circumstances, including the amount of tax
due in prior years, whether substantial underpayments have been made in
other years, and whether an individual made a bona fide and reasonable
attempt to locate, gather, and consult information, must be considered.
Individuals living outside the United States or Puerto Rico ( including
military personnel) are granted an automatic 4 - month extension for filing
a North Carolina income tax return if they attach a statement to their
return to explain that they were out of the country on the due date of the
return. Form D - 410 does not have to be filed. The time for payment of
the tax is also extended; however, interest is due on any unpaid tax from
the original due date of the return until the tax is paid. If an individual is
unable to file the return within the automatic 4 - month extension period,
an additional 2 - month extension may be obtained by filing Form D - 410
by August 15 and marking the “ out of country” indicator on the form.
A return may be filed at any time within the extension period but it must be
filed before the end of the extension period to avoid the late filing penalty.
If the Internal Revenue Service authorizes an extension of time for
federal tax - related deadlines for persons determined to be affected by a
Presidentially declared disaster, North Carolina will grant a similar
extension of time to file a return or report. For North Carolina income tax
purposes, the extension of time does not abate the payment of interest.
7. Amended Returns
North Carolina individual income tax returns may be amended by filing
an amended tax return, Form D - 400X. Instructions for filing the amended
return are provided on the reverse side of the form.
5
TAX RATE SCHEDULE
And your
taxable
If your filing income is But not
status is more than over The Tax is
Single $ 0 $ 12,750 6% of the taxable
income
$ 12,750 $ 60,000 $ 765 + 7% of the
amount over $ 12,750
$ 60,000 $ 120,000 $ 4,072.50 + 7.75% of
the amount over
$ 60,000
$ 120,000 - - - - - - - - - - $ 8,722.50 + 8.25% of
the amount over
$ 120,000
Head of $ 0 $ 17,000 6% of the taxable
Household income
$ 17,000 $ 80,000 $ 1,020 + 7% of the
amount over $ 17,000
$ 80,000 $ 160,000 $ 5,430 + 7.75% of the
amount over $ 80,000
$ 160,000 $ - - - - - - - - - - $ 11,630 + 8.25% of
the amount over
$ 160,000
Married filing $ 0 $ 21,250 6% of the taxable
Jointly or income
Qualifying $ 21,250 $ 100,000 $ 1,275 + 7% of the
Widow( er) amount over $ 21,250
$ 100,000 $ 200,000 $ 6,787.50 + 7.75% of
the amount over
$ 100,000
$ 200,000 - - - - - - - - - - $ 14,537.50 + 8.25% of
the amount over
$ 200,000
Married filing $ 0 $ 10,625 6% of the taxable
Separately income
$ 10,625 $ 50,000 $ 637.50 + 7% of the
amount over $ 10,625
$ 50,000 $ 100,000 $ 3,393.75 + 7.75% of
the amount over
$ 50,000
$ 100,000 - - - - - - - - - - $ 7,268.75 + 8.25% of
the amount over
$ 100,000
8. Tax Liability
If North Carolina taxable income is less than $ 68,000, the tax liability
must be determined by using the Tax Table in the individual income tax
instructions. If taxable income is $ 68,000 or more, use the Tax Rate
Schedule below to compute the tax.
6
II. Subject: Filing Requirements ( G. S. 105- 152)
1. General
The minimum gross income filing requirements under North Carolina
law are different from the filing requirements under the Internal Revenue
Code because North Carolina law does not adjust the standard deduction
and personal exemption for inflation as required by the Internal Revenue
Code. See pages 11 and 12 for the North Carolina standard deduction
and personal exemption amounts. The amounts are reflected in the
charts for minimum gross income filing requirements on pages 7 and 8
that follow.
2. Individuals Required to File a North Carolina Individual Income
Tax Return
The following individuals are required to file a North Carolina individual
income tax return:
a. Every resident of North Carolina whose income for the taxable
year equals or exceeds the amount for the individual’s filing status
shown in Chart A or B which follows.
b. Every part - year resident who received income while a resident of
North Carolina or who received income while a nonresident
attributable to the ownership of any interest in real or tangible
personal property in North Carolina or derived from a business,
trade, profession, or occupation carried on in North Carolina, or
derived from gambling activities in North Carolina and whose total
income for the taxable year equals or exceeds the amount for the
individual’s filing status shown in Chart A or B which follows.
c. Every nonresident who received income for the taxable year from
North Carolina sources that was attributable to the ownership of
any interest in real or tangible personal property in North Carolina
or derived from a business, trade, profession, or occupation carried
on in North Carolina, or derived from gambling activities in North
Carolina and whose total income for the taxable year equals or
exceeds the amount for the individual’s filing status shown in Chart
A or B which follows.
3. Minimum Gross Income Filing Requirements
The minimum gross income filing requirements for most people are
shown in Chart A, on the following page:
7
CHART A— FOR MOST TAXPAYERS
A Return is Required if
Filing Status Federal Gross Income Exceeds
( 1) Single $ 5,500
Single ( age 65 or older) $ 6,250
( 2) Married— Filing Joint Return $ 11,000
Married— Filing Joint Return,
( one age 65 or older) $ 11,600
Married— Filing Joint Return,
( both age 65 or older) $ 12,200
( 3) Married— Filing Separate Return $ 2,500
( 4) Head of Household $ 6,900
Head of Household
( age 65 or older) $ 7,650
( 5) Qualifying Widow( er)
with dependent child $ 8,500
Qualifying Widow( er)
( age 65 or older) $ 9,100
If an individual was not required to file a federal income tax return but
had gross income inside and outside North Carolina that equals or exceeds
the amount for the individual’s filing status in Chart A, a federal return
must be completed and attached to the North Carolina return to show
how the negative federal taxable income was determined.
The minimum gross income filing requirements for children and other
dependents are shown in Chart B on the following page. The filing
requirements in Chart B generally are applicable to those individuals
who can be claimed as a dependent by another person ( such as a parent).
Note: Earned income includes salaries, wages, tips, professional fees,
scholarships that must be included in income, and other
compensation received for personal services.
Unearned income includes taxable interest, dividends, capital
gains, pensions, annuities, and social security benefits.
8
Chart B— FOR CHILDREN AND OTHER DEPENDENTS
Single dependents. Were you either age 65 or older or blind?
No. You must file a return if any of the following apply to you.
• Unearned income was over $ 500
• Earned income was over $ 3,000
• Gross income was more
than the larger of -
• $ 500, or
• Earned income ( up to $ 2,750) plus $ 250
Yes. You must file a return if any of the following apply to you.
• Earned income was over $ 3,750 ($ 4,500 if 65 or older and blind)
• Unearned income was over $ 1,250 ($ 2,000 if 65 or older and blind)
• Gross income was more than -
The larger of- Plus This amount:
• $ 500, or $ 750 ($ 1,500 if 65
• Earned income ( up to $ 2,750) or older and blind)
plus $ 250
Unearned income includes taxable interest, dividends, capital gains, pensions,
annuities, and social security benefits. Earned Income includes salaries, wages,
tips, professional fees, scholarships that must be included in income, and other
compensation received for personal services.
Married dependents. Were you either age 65 or older or blind?
No. You must file a return if any of the following apply to you.
• Gross income was at least $ 10 and your spouse files a
separate return and itemizes deductions.
• Unearned income was over $ 500
• Earned income was over $ 3,000
• Gross income was more
than the larger of -
• $ 500, or
• Earned income up to $ 2,750 plus $ 250
Yes. You must file a return if any of the following apply.
• Earned income was over $ 3,600 ($ 4,200 if 65 or older and blind)
• Unearned income was over $ 1,100 ($ 1,700 if 65 or older and blind)
• Gross income was at least $ 10 and your spouse files a separate
return and itemizes deductions
• Gross income was more than -
The larger of- Plus This amount:
• $ 500, or $ 600 ($ 1,200 if 65
• Earned income up to 2,750 or older and blind)
plus $ 250
}
}
9
4. Joint Returns ( G. S. 105- 152)
G. S. 105 - 152 requires that a husband and wife file a joint State return if:
a. They file a joint federal income tax return and
b. Both spouses are residents of North Carolina or both spouses had
North Carolina taxable income.
All other individuals must file separate returns.
On joint returns, both spouses are jointly and severally liable for the
tax due. However, if a spouse has been relieved of any liability for federal
income tax under Internal Revenue Code Section 6015, that spouse would
not be liable for the corresponding State income tax liability.
If an individual files a joint federal return but files a separate North
Carolina return, the individual must complete a separate federal return
and attach it to the North Carolina income tax return to show how the
federal taxable income would be determined on a separate federal return.
In lieu of completing a separate federal return, an individual may submit
a schedule showing the computation of the separate federal taxable
income. In this case, an individual must attach a copy of the joint federal
return unless the federal return reflects a North Carolina address.
In determining the federal taxable income on the separate federal return,
deductions are allowable only to the spouse responsible for payment of
the item and who actually paid the amount during the tax year. In the
case of a joint obligation, nonbusiness deductions ( except for medical
expenses) are allowable to the spouse who actually paid the item; or if a
joint obligation is paid from a joint checking account, the deductions must
be allocated between the spouses according to their respective adjusted
gross income. In determining the amount of medical expenses paid by
each spouse from a joint checking account, each spouse is considered to
have paid their own medical expenses.
10
III. Subject: Computation of Taxable Income ( G. S. 105- 134.2 -
G. S. 105- 134.5)
1. General
The starting point in determining North Carolina taxable income is
taxable income for federal income tax purposes, subject to the following
additions, deductions and transitional adjustments. These adjustments
do not apply to all individuals. Each individual should determine if any of
the adjustments apply to his or her return.
2. Additions to Federal Taxable Income ( G. S. 105- 134.6)
Federal taxable income must be increased by the following additions
to the extent the amounts are not included in federal taxable income:
a. Interest received upon obligations of states other than North
Carolina and their political subdivisions;
This addition includes that portion of an exempt interest dividend
from a regulated investment company ( mutual fund) that represents
interest on direct obligations of states and their political subdivisions
other than North Carolina. ( See page 53 for additional information
on regulated investment companies.)
b. Any amount allowed as a deduction from gross income that is
taxed by a separate tax under the Internal Revenue Code. This
includes lump - sum distributions from certain employees’ retirement
plans which a taxpayer may elect to exclude from taxable income
in the regular tax computation and compute the tax separately.
c. State, local, and foreign income taxes or general sales taxes deducted
on the federal return.
d. The amount claimed for domestic production activities income. The
federal Jobs Creation Act of 2004 allows a deduction equal to a portion
of the qualified production activities income. North Carolina did not
adopt the federal provision allowing the deduction for domestic
production activities income.
e. The market price of donated gleaned crops for which a tax credit
was claimed on the North Carolina individual income tax return.
f. The difference in the standard deduction for federal and State
income tax purposes and the difference in the personal exemption
for federal and State income tax purposes. These adjustments are
necessary because the federal standard deduction amounts and
personal exemption amounts will be adjusted each year, if necessary,
for inflation. North Carolina does not have a similar provision.
11
Standard Deduction Chart for Most People
Do Not use this chart if you or your spouse were 65 or older or blind,
Or if someone can claim you as a dependent.
Standard Deduction Chart for
People Age 65 or Older or Blind
If someone can claim you as a dependent, use the worksheet for dependents instead.
If your filing status is:
Single 1 $ 3,750
2 $ 4,500
Head of household 1 $ 5,150
2 $ 5,900
Married filing separately 1 $ 3,600
2 $ 4,200
3 $ 4,800
4 $ 5,400
Check if: You were 65 or Older Blind
Your spouse was 65 or Older Blind
Enter the number of boxes checked above
Note: If married filing separately, include the number of
boxes checked for your spouse in the total number only
if your spouse had no gross income and was not claimed
as a dependent by another taxpayer.
If your filing status is: Your standard deduction is:
Single $ 3,000
Married filing jointly/ Qualifying widow( er) $ 6,000
Married filing separately
If spouse does not claim itemized deductions $ 3,000
If spouse claims itemized deductions 0
Head of household $ 4,400
Married filing jointly/ 1 $ 6,600
Qualifying widow( er) 2 $ 7,200
3 $ 7,800
4 $ 8,400
And the
total number
of boxes
you have
checked is:
Your standard deduction is:
The charts that follow show the North Carolina standard deduction
for individuals who are not claimed as dependents by another taxpayer.
The worksheet that follows is used to calculate the North Carolina
standard deduction for individuals who can be claimed as dependents by
another taxpayer.
12
The standard deduction is zero for a married individual filing separately
for federal income tax purposes whose spouse claims itemized deductions.
The standard deduction for nonresident aliens and individuals filing a
short year return due to a change of accounting period is zero.
The personal exemption for North Carolina purposes is $ 2,500 for a
taxpayer whose federal adjusted gross income is less than the amount
shown for his filing status in the chart that follows. For a taxpayer with
federal adjusted gross income equal to or more than the threshold amount,
the personal exemption is $ 2,000.
Filing Status Adjusted Gross Income
Married filing jointly $ 100,000
Head of household $ 80,000
Single $ 60,000
Married filing separately $ 50,000
1. Enter amount of earned income
( Earned income defined below) + $ 250 Enter total 1. ______________
2. Minimum amount. ....................................................................................... 2. ______________
3. Enter the larger of line 1 or line 2. ........................................................... 3. ______________
4. Enter on line 4 the amount shown for your filing status
• Single, enter $ 3,000
• Married filing jointly/
Qualifying widow( er), enter $ 6,000
• Married filing separately, enter $ 3,000
• Head of household, enter $ 4,400 ......................................................... 4. ______________
5. Enter the smaller of lines 3 or 4. If under 65 and not blind,
Stop Here and enter this amount on the appropriate line of
Form D - 400 ................................................................................................. 5. ______________
6. a. Check if: You were 65 or Older Blind
Your spouse was 65 or Older Blind
b. Enter the number of boxes you have checked
Note: If married filing separately, include the number of boxes checked for
your spouse in the total number checked only if your spouse had no gross income
and was not claimed as a dependent by another taxpayer.
c. Multiply $ 750 ($ 600 if married filing jointly or separately,
or qualifying widow( er)) by the number of boxes you
entered on line 6b above and enter the result ................................. 6c. _____________
7. Add lines 5 and 6c. Enter the total here and on the appropriate line
of Form D - 400 ............................................................................................ 7. ______________
Earned income includes salaries, wages, tips, professional fees, and other compensation received
for personal services you performed. It also includes any amount received as a scholarship that you
must report in income.
Standard Deduction Worksheet for Dependents
Use this worksheet only if someone can claim you as a dependent
$ 500
13
g. The amount of federal estate tax that is attributable to income in
respect of a decedent and that is deducted under Section 691 ( c)
of the Internal Revenue Code.
h. The amount by which the basis of property for federal purposes
exceeds the basis for State purposes upon disposition of the
property.
i. The amount of net operating loss carried over to a taxable year to
the extent the loss is not absorbed and will be carried forward to
subsequent years.
j. The amount of all tax credits passed through to an individual by an
S corporation, with the exception of the credit for tax paid to another
state or country and the credit for certain real property donations.
Example: An S corporation with two 50% shareholders claims a
$ 1,000 tax credit for creating jobs. Each shareholder claims the
jobs tax credit of $ 500 on their individual income tax return. An
addition to federal taxable income of $ 500 is required on each
shareholder’s State return.
k. With respect to a child’s unearned income reported by a parent,
the amount of the child’s unearned income in excess of $ 500 but
not exceeding $ 1,600. When a parent elects to report a child’s
unearned income, the child is treated as having no gross income
for the year and is not required to file a federal income tax return.
A parent electing to report a child’s unearned income for federal
tax purposes must add to 2005 federal taxable income the amount
of the child’s unearned income in excess of $ 500 but not exceeding
$ 1,600.
l. The amount of qualifying expenses for which an income tax credit
for qualifying expenses of a film or television production company
was claimed under G. S. 105 - 151.29.
3. Deductions from Federal Taxable Income ( G. S. 105- 134.6)
Federal taxable income must be decreased by the following deductions
to the extent the amounts are included in federal taxable income:
a. Interest upon direct obligations of the United States or its
possessions;
Interest earned from obligations that are merely backed or
guaranteed by the United States Government will not qualify for
deduction from an individual’s income. The deduction from income
will not apply to distributions which represent gain from the sale or
other disposition of the securities, nor to interest paid in connection
with repurchase agreements issued by banks and savings and loan
associations. The deduction will not apply to any portion of a
distribution from an individual retirement account ( IRA).
The following are examples of interest on bonds, notes, or other
obligations that must be deducted from federal taxable income, if
such bonds, notes, or other obligations are direct obligations of:
14
( 1) Puerto Rico, the Virgin Islands and Guam
( 2) A Federal Land Bank
( 3) A Federal Home Loan Bank
( 4) A Federal Intermediate Bank
( 5) Farm Home Administration
( 6) Export - Import Bank of the United States
( 7) Tennessee Valley Authority
( 8) Banks for Cooperatives
( 9) U. S. Treasury bonds, notes, bills, certificates and savings bonds
( 10) Production Credit Association
( 11) Student Loan Marketing Association
( 12) Commodity Credit Corporation
( 13) Federal Deposit Insurance Corporation
( 14) A Federal Farm Credit Bank
( 15) Federal Financing Bank
( 16) Federal Savings and Loan Insurance Corporation
( 17) General Insurance Fund
( 18) United States Postal Service
( 19) Resolution Funding Corporation
( 20) Financing Corporation ( chartered by the Federal Housing
Finance Board — 12 USCS 12 - 1441)
b. Interest on bonds, notes, and other obligations of the State of North
Carolina or any of its political subdivisions;
c. Interest on obligations and gain from the sale or disposition of
obligations issued before July 1, 1995 if North Carolina law under
which the obligations were issued specifically exempts the interest
or gain ( With respect to North Carolina obligations issued after July 1,
1995, the income tax treatment of gains from the sale or disposition of
such obligations is the same for federal and State purposes.);
Examples:
( 1) Interest on bonds, notes, debentures, or other evidence of
the indebtedness issued under G. S. 131E - 28 by the North
Carolina Hospital Authorities, including gain from the sale
or exchange of these obligations.
( 2) Interest on bonds, notes, debentures, or other evidence of
indebtedness issued by the North Carolina Medical Care
Commission under the Health Care Facilities Finance Act
under the provisions of G. S. 131A - 21. Gain from the sale or
exchange of these obligations may also be deducted.
( 3) Interest and gain derived from obligations issued by the North
Carolina Housing Finance Agency under G. S. 122A - 19.
( 4) Interest and gain on bonds issued by the North Carolina
State Ports Authority under G. S. 143B - 456( g).
( 5) Interest on bonds, notes, debentures, and any other evidence
of indebtedness issued by a North Carolina Housing
Authority ( including any corporate agent authorized by
15
Article 1 of Chapter 157 of the General Statutes to exercise
the powers of the authority) under the provisions of G. S.
157 - 26. Gain from the sale or exchange of these obligations
is not deductible.
( 6) Interest and gain derived from bonds issued under the Joint
Municipal Electric Power and Energy Act under G. S. 159B - 26.
( 7) Interest on bonds issued by the authorities created under
the Industrial and Pollution Control Facilities Financing Act,
G. S. 159C - 14.
( 8) Income from securities, evidence of indebtedness, and shares
of capital stock issued by a corporation organized to promote,
develop, and advance the prosperity and economic welfare of
the State of North Carolina under the provisions of G. S. 53A -
15. Gain from the sale or exchange of such obligations is deductible.
( 9) Income from bonds issued by boards of trustees of State
supported colleges and universities in North Carolina including
any gain from the sale or exchange of them under G. S. 116 - 183
and 116 - 196.
( 10) Interest and gain received from bonds and notes issued under
the provision of the Higher Education Facilities Finance Act
by the North Carolina Educational Facilities Finance Agency
under G. S. 115E - 21.
( 11) Interest and gain received on obligations issued under
Chapter 122D ( The North Carolina Agriculture Finance Act)
by the North Carolina Agriculture Finance Authority under
G. S. 122D - 14.
d. Taxable portion of social security benefits received under Title II
of the Social Security Act and any Tier I or Tier II Railroad
Retirement benefits received under the Railroad Retirement Act
of 1937;
e. An amount by which any federal income tax deduction is
disallowed because of the allowance of a federal income tax credit
for part or all of the expense comprising the deduction to the extent
that a similar State income tax credit is not allowed;
Example 1: If an individual itemizes deductions and claims the
mortgage interest tax credit on the federal tax return because of
participating in the mortgage credit certificate program ( MCC),
the individual may reduce North Carolina taxable income by the
amount that the mortgage interest deduction was reduced due to
claiming the mortgage interest credit on the federal tax return.
Example 2: If an individual claimed the Hope or Lifetime Learning
tax credit on the federal return in lieu of the deduction for higher
education expenses allowed under Section 222 of the Internal
Revenue Code, the individual may claim a deduction of up to $ 4,000
for such expenses on the 2005 State return.
16
f. Refunds of state, local, and foreign income taxes;
g. Up to $ 4,000 in retirement benefits from one or more federal,
state, or local government retirement plans ( See IV. Bailey
Settlement on page 23 to determine if more than $ 4,000 of
government retirement benefits may be deducted.)
h. Up to $ 2,000 in retirement benefits from one or more private
retirement plans; If an individual receives federal, state, or local
government retirement benefits and also receives other qualified
retirement benefits, the total deduction is limited to $ 4,000. For
married couples filing a joint return, the maximum dollar amount
of retirement benefits that may be deducted from federal taxable
income applies separately to the benefits received by each spouse,
so that the maximum deduction on a joint return is $ 8,000.
The $ 4,000 deduction is applicable to retirement benefits received from the
governments of territories and possessions of the United States.
If an individual received retirement benefits during the year from one
or more private retirement plans other than state, local, or federal
government retirement plans, the individual may deduct the amount
received or $ 2,000, whichever is less. Married individuals filing a
joint return where both received such retirement benefits may each
deduct up to $ 2,000 for a potential total deduction of $ 4,000.
“ Retirement benefits” are amounts paid to a former employee or
to a beneficiary of a former employee under a written retirement
plan established by the employer to provide payments to an
employee or beneficiary after the end of the employee’s
employment with the employer where the right to receive the
payment is based upon the employment relationship. For self -
employed individuals, retirement benefits are amounts paid to an
individual, or beneficiary under a written retirement plan established
by the individual to provide payments after self - employment ends.
Retirement benefits also include amounts received from an
individual retirement account or from an individual retirement
annuity ( IRA).
An individual is not required to have ceased employment to qualify
for the $ 2,000 deduction for distributions from an individual
retirement account or an individual retirement annuity.
The deduction for retirement benefits is allowed only to the extent
the benefits are included in federal taxable income. If an individual
elects to roll - over the distribution from an employer’s plan or from
an individual retirement account, no deduction is allowed since the
amount rolled over is not included in taxable income.
A change in the structure of a corporate employer which causes a
distribution to be paid to the employee from the employer’s
retirement plan does not entitle the employee to claim the deduction
for retirement benefits from such distribution. For example,
Company A is merged with Company B. An employee of A
17
continues to work for the merged company. During the tax year,
the employee received a distribution of $ 5,000 representing the
employee’s total credit in the non - contributory retirement plan of
Company A. The employee would not be entitled to the $ 2,000
deduction since the employee had not ceased employment.
Since short - term disability benefits from the Disability Income Plan
of North Carolina administered for the benefit of North Carolina
teachers and state employees are not paid to a former employee
under a retirement plan after the end of the employee’s employment,
the benefits are not subject to the $ 4,000 deduction from federal
taxable income. Long - term disability benefits are payable after
the conclusion of the short - term disability period or after salary
continuation payments cease, whichever is later. Recipients of
long - term disability benefits under the Disability Income Plan of
North Carolina are former employees and they are entitled to the
$ 4,000 deduction from federal taxable income.
Benefits paid to federal civil service employees who become
disabled prior to becoming age 60 upon separation from service
are paid to a former employee under a retirement plan after the
end of the employee’s employment and are subject to the $ 4,000
deduction from federal taxable income.
Survivors of a member of the armed forces who receive benefits
from the Retired Serviceman’s Family Protection Plan or the
Survivor’s Benefits Plan as the result of taking a reduction in
retirement pay are subject to the deduction of up to $ 4,000 from
federal taxable income.
i. The amount of North Carolina inheritance or estate tax paid that
is attributable to an item of income in respect of a decedent;
The deduction from federal taxable income is determined by multiplying
the amount of North Carolina inheritance or estate tax paid on all
property transferred to the particular beneficiary, less the North Carolina
inheritance or estate tax which would have been paid if the item of
income in respect of a decedent had not been included, by a fraction,
the numerator of which is the income in respect of a decedent the
beneficiary included in federal taxable income, as adjusted, and the
denominator of which is the total income in respect of a decedent
transferred to the beneficiary. The deduction is allowable in the year
the item of income is included in federal taxable income.
j. Income earned or received by an enrolled member of a federally
recognized Indian tribe if such income is derived from activities on
a federally recognized Indian reservation while the member resided
on the reservation. Intangible income having a situs on the reservation
and retirement income associated with activities on the reservation
are considered income derived from activities on the reservation.
k. Repayments of items of income included in gross income in a
prior year under the claim - of - right doctrine for which the taxpayer
18
reduces his tax under Section 1341 of the Internal Revenue Code
in the year of repayment;
For federal income tax purposes, if the repayment claimed under a
claim of right is substantial ( more than $ 3,000) and there is insufficient
income in the later year to offset the deduction, an individual may
claim a credit if the benefit received by claiming the credit is greater
than that received by claiming a deduction for the repayment. A
taxpayer who qualifies for the credit on the federal return is still entitled
to the deduction for the amount repaid on the State return. The taxpayer
is also considered to have made a payment of North Carolina income
tax on the repayment. The payment, which is applied against the tax
liability for the year in which the repayment was made, is the amount
the tax was increased in the earlier year because the income was
included in gross income minus the amount the tax for the current
year was decreased because the repayment was deductible. Individuals
may claim the payment on the individual income tax return by including
the payment on the same line as S corporation payments.
Example: In 2004, a single taxpayer reported North Carolina
taxable income of $ 25,000 on which he paid tax of $ 1,624. The
taxpayer’s only income was sales commissions. In 2005, it is
determined that the commissions were erroneously computed for
2004. Accordingly, the taxpayer pays back $ 8,000 of the commissions.
The North Carolina taxable income for 2005 without regard to the
$ 8,000 repayment is $ 4,000. The taxpayer qualifies for a credit on
the federal return for the amount repaid. The tax payment to be
claimed on the 2005 North Carolina return is determined as follows:
2004
Tax on $ 25,000 = $ 1,624
Tax on $ 17,000 ($ 25,000 - $ 8,000) = 1,064
$ 560
2005
Tax on $ 4,000 = $ 242
Tax after deducting $ 8,000 payment = 0
$ 242
Payment to be claimed on the 2005
North Carolina return $ 318
l. The amount by which the basis of property for State purposes exceeds the
basis for federal purposes upon disposition of the property. The deduction
can be claimed only in the year in which the property is disposed.
m. Up to $ 35,000 of any severance wages received as a result of a
taxpayer’s permanent, involuntary termination from employment
through no fault of the employee is deductible from federal taxable
income. The severance wages deducted as a result of the same
termination may not exceed $ 35,000 for all taxable years in which the
19
wages were received. “ Stay on pay” does not qualify for the deduction.
Severance wages do not include payments that represent compensation
for past or future services. Compensation for past or future services
includes payment for any of the following:
( 1) Accumulated sick leave, vacation time, or other unused benefits;
( 2) Bonuses based on job performance; and
( 3) Payments in consideration of any agreement not to compete with the
employer or in consideration of a contractual or legal claim.
n. See IV. Bailey Settlement.
o. Interest, investment earnings, and gains of a trust established by two
or more manufacturers that signed a settlement agreement with the State
to settle claims for damages attributable to a product of the manufacturers.
p. The amount paid to an individual from the Disaster Relief Reserve
Fund in the Office of State Budget, Planning, and Management for
hurricane relief or assistance, but not including payments received for
goods or services.
q. An amount equal to 20 percent of the total additional first - year
depreciation an individual added back on the 2002, 2003, and 2004
State returns. North Carolina did not adopt the additional first -
year depreciation provisions in the federal Jobs Creation and Worker
Assistance Act of 2002 or the federal Jobs and Growth Tax Relief
Reconciliation Act of 2003. Instead, an adjustment was required
on the 2002, 2003, and 2004 returns for a certain percentage of
the first - year depreciation claimed on the federal return for the
applicable year. Any amount of additional first - year depreciation
that an individual added to federal taxable income on the 2002,
2003, or 2004 State returns may be deducted in five equal
installments beginning with the State tax return for 2005.
If a taxpayer disposes of an asset on which additional first - year
depreciation was added back on the 2002, 2003, or 2004 State
return, the taxpayer is entitled to claim the 20 percent deduction
over the five year period even though the taxpayer no longer owns
the asset.
If a taxpaying entity that added back additional first - year
depreciation on the State return merges with another entity, the
new entity is not entitled to claim the 20 percent deduction.
4. Transitional Adjustments ( G. S. 105- 134.7)
The following transitional adjustments are required because of
differences in the way State and federal law treated certain tax
transactions prior to January 1, 1989.
a. Amounts that were included in the basis of property under federal
law but not under State law prior to January 1, 1989, must be
added to taxable income in the year of disposition of the property.
These adjustments include the increase in basis for federal gift tax
20
paid on property received as a gift and in certain cases where the
individual was permitted under federal law to capitalize certain
expenditures for interest and taxes.
b. Amounts that were included in the basis of property under State
law but not under federal law prior to January 1, 1989, must be
deducted from an individual’s taxable income in the year of
disposition of the property. Deductions of this type include the
increase in basis for State gift tax paid on property received as a
gift and certain business expenditures that an individual elected to
expense under Section 179 of the Internal Revenue Code but which
were required to be capitalized for State income tax purposes.
c. A loss or deduction that was incurred or paid and deducted in full
for North Carolina income tax purposes under prior State law in a
taxable year beginning before January 1, 1989, but was carried
forward and deducted from federal taxable income in a taxable year
beginning on or after January 1, 1989, must be added to taxable income.
Example: The full amount of a capital loss incurred in 1988 would
have been deductible on an individual’s 1988 State income tax
return but on his federal income tax return the amount of the
deductible loss would have been limited to his capital gains plus
$ 3,000 ($ 1,500 if married and filing a separate return). Any
remaining loss could be carried forward to subsequent tax years
and deducted on his federal income tax return in computing his
federal taxable income. In this instance, the individual must add
back each year that portion of the 1988 loss deducted from his
federal taxable income in arriving at the amount of his North
Carolina taxable income.
In determining the amount of a capital loss to add back, short - term
capital losses from taxable years beginning prior to January 1,
1989, must be applied before applying short - term capital losses
incurred in taxable years beginning on or after January 1, 1989,
and before applying long - term capital losses from any year. Long -
term capital losses from taxable years beginning prior to January
1, 1989, must be applied before applying long - term capital losses
incurred in taxable years beginning on or after January 1, 1989.
Example: An individual carries over $ 6,000 of capital losses from
years beginning prior to January 1, 1989, consisting of $ 4,000 of
short - term losses and $ 2,000 of long - term losses. In 1989, the
individual incurs additional capital losses of $ 2,500, consisting of
$ 1,500 of short - term losses and $ 1,000 of long - term losses. The
individual claims a capital loss deduction of $ 3,000 on his federal
income tax return. In 1990 and 1991 the individual has no additional
capital gains or losses and claims a $ 3,000 capital loss carry - over
on his 1990 federal income tax return and the balance of $ 2,500
capital loss carry - over on his 1991 federal income tax return. The
taxpayer would be required to add back the following amounts as
transitional adjustments: 1989 — $ 3,000 ( a portion of the short -
21
term capital loss from 1988); 1990 — $ 1,500 consisting of the
$ 1,000 balance of the 1988 short - term loss and $ 500 of the 1988
long - term loss; 1991 — $ 1,500 consisting of the remaining 1988
long - term loss carry - over.
Example: Generally, for federal income tax purposes for tax years
beginning on or after January 1, 1987, to the extent that the total
deductions from passive activities exceed the total income from
such activities for the tax year, the excess ( passive activity loss) is
not allowed as a deduction for that year. A disallowed passive loss
is allowed to be carried forward as a deduction from passive
activity income in the next succeeding tax year. Generally, losses
from passive activities may not be deducted from other types of
income ( e. g. wages, interest, or dividends). A passive activity is
one that involves the conduct of any trade or business in which the
taxpayer does not materially participate. Any rental activity is a
passive activity regardless of whether the taxpayer materially
participates. Special rules apply to rental activities. Under State
law, a passive loss carried forward from a tax year beginning prior
to January 1, 1989, must be added back to federal taxable income
since the entire loss was deductible on the taxpayer’s return for
the year the loss was incurred.
d. Amounts deducted on an individual’s federal income tax return as
net operating losses brought forward from tax years beginning
prior to January 1, 1989, must be added to federal taxable income.
For tax years prior to January 1, 1989, State law allowed a net
economic loss to be carried forward to subsequent years but was
computed differently from the federal net operating loss. Prior State
law did not permit the loss to be carried back to prior tax years as did
federal law. See V. Net Operating Losses for additional information.
Example: An individual sustains a business loss of $ 100,000 in
1988, had no other business income or business expenses for that
year, and received interest income of $ 82,000 from City of Raleigh
bonds during the taxable year. For federal income tax purposes,
the individual would have sustained a net operating loss of $ 100,000.
If the individual had no income in the prior three tax years to
offset the net operating loss, he could carry the $ 100,000 loss
forward for up to 15 years and deduct it as a net operating loss on
his subsequent federal income tax returns. Under prior State law,
the individual would have incurred a net economic loss of $ 18,000
( business loss of $ 100,000 less nontaxable income of $ 82,000)
that could be carried forward to up to five years after reducing it
by both taxable and nontaxable income. In this situation, the
individual must add back the net operating loss deduction claimed
on his federal income tax return.
e. Adjustments must also be made in the taxable income of a
shareholder of an S corporation. For a discussion of the tax status
22
of distributions from S corporations to shareholders in tax years
beginning on or after January 1, 1989, see VII. S Corporations.
f. Under the “ tax benefit rule,” the recovery of an amount deducted
or credited in an earlier year is included in federal taxable income
in the current ( recovery) year, except to the extent the earlier
year’s deduction or credit did not reduce federal income tax
imposed in that year. Income attributable to such recovery items
which did not provide a tax benefit for federal income tax purposes
but did provide a tax benefit for State purposes for taxable years
beginning prior to January 1, 1989, must be added to federal taxable
income.
Other additions and deductions to federal taxable income may be
required to ensure that the transition to the tax changes effective January
1, 1989, does not result in the double taxation of income, the exemption
of otherwise taxable income or double allowance of deductions.
23
V. Subject: Bailey Settlement
As a result of the North Carolina Supreme Court’s decision in Bailey
v. State of North Carolina and the settlement subsequently reached in
that case, North Carolina may not tax retirement benefits received by a
retiree ( or by a beneficiary of a retiree) from qualifying State, local, or
federal retirement systems if the retiree was vested in the retirement
system as of August 12, 1989. For most government retirement sys -
tems, a person is vested if the person had five or more years of credit -
able service in a qualifying State, local or federal retirement system as of
August 12, 1989. For certain retirement systems, the vesting period is less.
1. Qualifying State or Local Retirement System
The following retirement systems were designated as a North Carolina
state or local governmental retirement system:
System Law Creating the System
North Carolina Teachers’ and State Employees’ G. S. 135, Article 1
Retirement System ( TSERS)
Optional Retirement Program available to G. S. 105 - 135 - 5.1
administrators and faculty of the University of North
Carolina system in lieu of TSERS
North Carolina Local Governmental Employees’ G. S. 128, Article 3
Retirement System
North Carolina Consolidated Judicial Retirement G. S. 135, Article 4
System
North Carolina Legislative Retirement System G. S. 120, Article 1A
North Carolina Disability Income Plan ( both short - G. S. 135, Article 6
term and long - term disability benefits)
North Carolina Supplemental Retirement Income Plan G. S. 135, Article 5
North Carolina Supplemental Retirement Income Plan G. S. 143 - 166.30( d)
for State Law Enforcement Officers
North Carolina Deferred Compensation Plan G. S. 143B, Article 9
North Carolina National Guard Pension Fund G. S. 127A - 40
North Carolina Sheriffs’ Supplemental Pension Fund G. S. 143, Article 12H
North Carolina Registers of Deeds’ Supplemental G. S. 161, Article 3
Pension Fund
North Carolina Supplemental Retirement Plan for G. S. 143 - 166.50( e)
Local Governmental Law Enforcement Officers
Separate Insurance Benefits Plan for State and Local
Governmental Law Enforcement Officers G. S. 143 - 166.60
North Carolina Firemen’s and Rescue Squad Workers’
Pension Fund G. S. 58, Article 86
24
No local government optional contribution plans, similar to the State’s
Supplemental Retirement Income Plan and Deferred Compensation Plan,
were afforded tax exemption prior to August 12, 1989. Therefore,
retirement benefits from local optional contribution plans are not subject
to future tax exemption.
Teachers and other employees of North Carolina’s public schools
have the option of contributing to optional contribution plans established
pursuant to section 403( b) of the Code. Distributions from these plans
may not be excluded from taxable income under the settlement.
2. Vesting Period for Qualifying State or Local Retirement Systems
The general rule is that a participant in a qualifying State or local retirement
system is vested if the participant had five or more years of creditable service
as of August 12, 1989. The general rule does not apply to qualifying optional
contribution plans, however, or to certain other qualifying plans.
Participants in the State’s Supplemental Retirement Income Plan
( Internal Revenue Code § 401( k)) or the State’s Deferred Compensation
Plan ( Code § 457) are vested in the plan as of August 12, 1989, if they
contributed or contracted to contribute to the plan by August 12, 1989. If
the participant contributed any money to a plan before August 12, 1989,
all future withdrawals from that plan are excludable from tax.
Contributions to one plan prior to August 12, 1989, do not qualify
contributions to the other plan as vested. If a State employee began
contributing to the § 401( k) plan in June 1989, and to the § 457 plan in
October 1989, the employee is vested only in the § 401( k) plan. Participants
in the State’s Supplemental Retirement Income Plan or the State’s
Deferred Compensation Plan may have chosen an annuity as an
investment option. In some cases, they receive the annuity payments
and the subsequent tax information statement from the annuity company
instead of the plan administrator. These amounts also qualify for future
tax exemption if the retiree was vested.
Participants in the North Carolina Firemen’s and Rescue Workers’
Pension Plan are vested as of August 12, 1989, only if the individual had
both five years of service and had paid five years of contributions to the
plan by August 12, 1989. Sheriffs receiving benefits from the North
Carolina Sheriffs’ Supplemental Pension Fund and Registers of Deeds
receiving benefits from the North Carolina Registers of Deeds’
Charlotte Firefighters’ Retirement System Session Laws 1947, Chapter 926, § 6( c)
Firemen’s Supplemental Fund of Hickory Session Laws 1971, Chapter 65
Winston - Salem Police Officers’ Retirement System Session Laws 1939, Chapter 296
Separate Insurance Benefits Plan for State and G. S. 143 - 166.60
Local Government Law Enforcement Officers
New Hanover County School Employees’ 1979 Session Laws, Chapter 1307
Retirement Plan
25
Supplemental Pension Fund are vested as of August 12, 1989, only if the
sheriff or the register of deeds ( not a deputy or assistant) had five years
of service as a sheriff or a register of deeds and five years of participation
in the Local Government Employees’ Retirement System ( or equivalent
local plan) by August 12, 1989.
An employee in a qualifying State or local government retirement
system who was vested prior to August 12, 1989, and who leaves
employment remains vested if the employee later returns to work, provided
the employee did not withdraw his or her contributions to the retirement
system. If the employee withdrew his or her contributions, the employee
is no longer vested in the retirement system, even if the employee
subsequently buys back the service time, unless the employee returned
to employment in time to become vested again before August 12, 1989.
3. Qualifying Federal Retirement Systems
The following retirement systems were designated as a federal
governmental retirement system:
• Federal Civil Service Retirement System
• Federal Employees’ Retirement System
• Lighthouse Retirement System
• Thrift Savings Plan
• Foreign Service Retirement and Disability System and Pension System
• Military Retirement System
• Coast Guard Retirement System
• Central Intelligence Agency Retirement System
• Commissioned Corps of the Public Health Service Retirement System
• Comptrollers’ General Retirement Plan
• Judicial Plans & Pay for Federal Judges Treated as Retirement Pay by Federal Law, including:
- Judicial Retirement System
- Judicial Survivors’ Annuities System
- Court of Federal Claims Judges’ Retirement System
- Court of Veterans Appeals Judges’ Retirement Plan
- Judicial Officers’ Retirement System ( for Bankruptcy Judges and Magistrates)
- United States Tax Court Retirement Plan
- United States Tax Court Survivors’ Annuity Plan
- Retirement Plans for District Court Judges for the Northern Mariana Islands,
the Virgin Islands, and Guam
- Court of Appeals for the Armed Forces Judges Retirement System
• National Oceanic and Atmospheric Administration Retirement System
• Tennessee Valley Authority Retirement System and TVA Savings and Deferral
Retirement Plan
• Financial Institutions Retirement Fund ( Office of Thrift Supervision Employees)
• Federal Home Loan Bank Board Retirement Systems
• Federal Home Loan Mortgage Corporation Plan
• Federal Reserve Employees Retirement Plans and Thrift Plan
• Nonappropriated fund plans, including:
- Retirement Annuity Plan for Employees of Army and Air Force Exchange Service
- Supplemental Deferred Compensation Plan for Members of the
Executive Management Program ( Army and Air Force Exchange Service)
- Nonappropriated Fund Retirement Plan for Civilian Employees
- United States Army Nonappropriated Fund Retirement Plan
- Retirement Plan for Civilian Employees of United States Marine Corps Morale,
Welfare, and Recreation Activities and Miscellaneous Nonappropriated Fund
Instrumentalities
- Navy Exchange Service Command Retirement Plan
- Navy Nonappropriated Fund Retirement Plan for Employees of Civilian Morale,
Welfare, and Recreation Activities
- Norfolk Naval Shipyard Pension Plan
- Retirement Savings Plan and Trust for Employees of the Army and Air Force
Exchange Service
- Coast Guard Nonappropriated Fund Retirement Plan
26
• District of Columbia Police Officers and Fire Fighters’ Retirement Fund and
Related Funds ( including payments to Secret Service and U. S. Park Police
covered by the Fund)
• District of Columbia Teachers’ Retirement Fund and Related Funds
• District of Columbia Judges’ Retirement Fund and Related Funds
• Uniformed Services University of the Health Sciences Plan
• Smithsonian Institution Defined Contribution Retirement Plan
• USDA Graduate School Plan
4. Vesting Period for Qualifying Federal Retirement Systems
Generally, participants in the qualifying federal retirement systems listed
above, including military retirees, are vested for purposes of the settlement if
they had five or more years of creditable service as of August 12, 1989. The
general rule, however, does not apply to the Thrift Savings Plan.
The Thrift Savings Plan has both an employee and an employer
component. The employee component is similar to the State’s § 401( k)
and § 457 plans and allows the employee to voluntarily contribute to the
Plan. The employee is vested in the employee component if the employee
first made a contribution to the plan prior to August 12, 1989. The employer
component includes both contributions by the employer of a fixed
percentage of the employee’s salary and contributions by the employer
that match the employee’s voluntary contributions. The employee is also
vested in the employer matching contributions if the employer first made
a matching contribution prior to August 12, 1989. An employee is vested
in the employer fixed component only if the employee had three years of
service ( two years of service for certain highly ranked employees) as of
August 12, 1989. One exception to the three - year rule is that an employee
who died prior to completing the mandatory three years is still considered
vested if the date of death was on or before August 12, 1989.
As explained above, it is possible for a participant in the Federal Thrift
Savings Plan to be vested as of August 12, 1989, in some components of the
plan while at the same time not being vested in other components. The
annual tax information statement ( Form 1099 - R) does not distinguish between
the various components when reporting the amount distributed during the
year; therefore, the recipient cannot readily determine the amount to exclude
from North Carolina income tax. When a participant in the plan ceases
employment, the recipient is provided a Form TSP - 8, Thrift Savings Plan
Participant Statement, that identifies the cash balances in the various
components. To determine the proper amount to exclude, the recipient should
multiply the annual distribution by a fraction, the numerator of which is the
balance of the components in which the recipient is vested as of August 12,
1989. The denominator of the fraction is the total cash balance of all
components. That same fraction will be used for each year the recipient
receives distributions from the plan.
5. Rollover Distributions with Respect to Bailey Retirement Plans
The Economic Growth and Tax Relief Reconciliation Act of 2001 made
numerous changes with respect of pension portability. Beginning in 2002,
distributions from most types of retirement plans may be rolled over into
another retirement plan or into an IRA. Because rollover distributions
lose their character upon rollover, all distributions from a qualifying Bailey
27
retirement account in which the employee/ retiree was “ vested” as of
August 12, 1989, are exempt from State income tax regardless of the
source of the funds contained in the account. Conversely, qualifying tax -
exempt Bailey benefits rolled over into another retirement plan lose their
character and would not be exempt upon distribution from the other plan
unless that plan is a qualifying Bailey retirement account in which the
employee was vested as of August 12, 1989. ( Rollovers to IRAs will
always result in a loss of tax - exempt status since IRAs do not qualify
under the Bailey settlement.)
6. Benefits from Other Retirement Plans
Retirees receiving benefits from government retirement plans of other
states or territories were not class members in Bailey and are not entitled to
recovery of taxes paid in earlier years or to tax exemption in future years,
except for the $ 4,000 deduction provided by G. S. 105 - 134.6( b)( 6). Private
retirement benefits remain taxable except for the $ 2,000 deduction.
28
V. Subject: Net Operating Losses ( G. S. 105- 134.7)
Prior to 1989, North Carolina law provided a measure of relief to
individual income taxpayers who incurred economic misfortune by
allowing losses qualifying as net economic losses as defined by G. S.
105 - 147( 9)( d)( 2) to be carried forward and deducted from future gross
income. With the adoption of federal taxable income as the starting point
in determining North Carolina taxable income in 1989, net operating losses
were recognized for State individual income tax purposes. The primary
differences between net operating losses and net economic losses are
( 1) nontaxable income is used to reduce the amount of a net economic
loss but is not used to reduce the amount of net operating loss, and ( 2)
net economic losses can only be carried forward while net operating
losses can be carried back and/ or forward.
1. Determining Net Operating Losses
Since federal taxable income is the starting point for determining North
Carolina taxable income, the amount of net operating loss determined
for federal income tax purposes is also the net operating loss for State
income tax purposes. Although adjustments to federal taxable income
may be required which cause North Carolina taxable income to be
different than federal taxable income in the year the loss is incurred, the
law does not require or permit a separate calculation of a net operating
loss for State purposes. The amount of net operating loss is the same for
State and federal purposes. However, a nonresident or part - year resident
must make an additional calculation to determine the portion of the total
net operating loss that is from North Carolina sources.
2. Net Operating Loss Carryovers
a. Since federal taxable income is the starting point for determining
North Carolina taxable income, the amount of net operating loss
carried over and absorbed for federal purposes is the same amount
carried over and deducted for State purposes. “ Absorbed” means
the amount of net operating loss carried to a year less the amount
of net operating loss carried forward from that year. If, in the year
to which the loss is carried, adjustments are required to the State
return which result in the taxpayer not receiving full benefit of the
carryover, no additional carryover of the portion of the loss not
resulting in a benefit is permitted.
b. For any year in which a net operating loss is carried over but not
completely absorbed for federal purposes, an addition to federal
taxable income is required on the State return for the amount of
net operating loss carried forward from that year.
Example: A taxpayer incurs a net operating loss of $ 75,000
in 2005. The taxpayer amends his 2003 federal return to
carry back the net operating loss and deducts the entire
loss in arriving at federal taxable income. Only $ 50,000 of
the loss is absorbed and $ 25,000 is carried forward to the 2004
29
federal return. To determine North Carolina taxable income,
the taxpayer must make an addition to federal taxable income,
as amended, of $ 25,000 on his amended 2003 State return.
c. Because North Carolina did not recognize net operating losses before
1989, a taxpayer may not carry forward a loss incurred prior to 1989.
G. S. 105 - 134.7( a)( 6) requires an addition to federal taxable income
for the amount of net operating loss carried forward from a tax year
prior to 1989 and deducted in arriving at federal taxable income.
3. Effect of Residency Status on Net Operating Losses
As stated earlier, the amount of net operating loss carried over and
absorbed for federal tax purposes is also the amount carried over and
deducted for State tax purposes. If the taxpayer is a nonresident or a
part - year resident in the year the net operating loss is incurred and a
resident in the year to which the loss is carried, the taxpayer receives
the full benefit of the deduction, regardless of whether the net operating
loss resulted from North Carolina source activities. If the taxpayer is a
resident in the year the net operating loss is incurred and a nonresident
or part - year resident in the year to which the loss is carried, the taxpayer
may subtract the entire portion of the net operating loss carried over and
absorbed for federal purposes that year from North Carolina source
income in the numerator of the fraction used to calculate North Carolina
taxable income for nonresidents and part - year residents. If the taxpayer
is a nonresident or a part - year resident in both the year the net operating
loss is incurred and the year to which the loss is carried, the taxpayer
must determine the portion of the net operating loss that was from North
Carolina sources. The numerator of the fraction is reduced by the
attributable portion of the North Carolina source net operating loss while
the denominator is reduced by the portion of the total net operating loss
carried over and absorbed in that year for federal purposes.
Example: A nonresident taxpayer incurs a net operating loss of $ 10,000
in 2005, $ 7,000 of which is from North Carolina sources. The portion
of the net operating loss that is from North Carolina sources is .70
($ 7,000 divided by $ 10,000). If the taxpayer carries the loss back to
2003 and deducts $ 4,000 in that year, the portion of that loss deemed
to be from North Carolina sources and subtracted in determining the
numerator of the fraction is $ 2,800 ($ 4,000 multiplied by .70). The
denominator is reduced by the entire $ 4,000.
The North Carolina source net operating loss is apportioned to all years
to which the total net operating loss is carried even if the taxpayer has
no other North Carolina source income in those years to which the net
operating loss may be applied.
4. Claiming a Net Operating Loss
a. Carrying back a net operating loss. – For federal tax purposes, a
taxpayer carrying back a net operating loss may use Federal Form
1040X or, if a refund is due, Federal Form 1045. North Carolina
does not have a form similar to Federal Form 1045; therefore, the
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taxpayer must use Form D - 400X to carry back the loss. A copy
of Federal Form 1045, including Schedule A, must be provided for
each year to which the loss is carried back. For any year in which
the loss is carried back but not completely absorbed, a copy of
Schedule B of Federal Form 1045 must also be provided. In lieu
of Federal Form 1045, a worksheet containing the same information
as Federal Form 1045 is acceptable.
b. Carrying a net operating loss forward. – For federal tax purposes,
a taxpayer carrying a net operating loss forward reports the loss
as “ Other Income” on the federal return. A copy of Federal Form
1045, Schedule A, or similar worksheet identifying the year in which
the net operating loss was incurred and showing how the net
operating loss was calculated must be attached to each State return
to which the loss is carried forward. For any year in which the
loss is carried forward but not completely absorbed, a copy of the
Worksheet for NOL Carryover included in Federal Publication
536 or a similar worksheet must also be provided.
c. Nonresidents and part - year residents. – A taxpayer who is a
nonresident or part - year resident in the year to which a net operating
loss is carried over must include a schedule showing the calculation
of the amount subtracted in arriving at the numerator of the fraction
used to determine North Carolina taxable income.
5. Statute of Limitations
For both State and federal tax purposes, the period of time in which a
taxpayer may claim a refund resulting from the carryback of a net
operating loss is extended beyond the general period of limitations for
claiming a refund. The period of time for claiming a refund from the
carryback of a net operating loss expires three years after the date the
return is due, including extensions, for the year in which the loss is
incurred, not the year to which the loss is carried. For example, a calendar
year taxpayer who incurs a net operating loss in tax year 2005 and files
the 2005 return by April 15, 2006, has until April 15, 2009 to file a claim
for refund of taxes paid for the tax year 2003 because of the carryback
of the net operating loss.
6. Calculation of Interest on Overpayments
Interest accrues on an overpayment of individual income tax from a
date 45 days after the latest of the following dates: ( 1) the date the final
return is filed; ( 2) the original due of the return; or ( 3) the date of the
overpayment, until the refund is paid. An overpayment resulting from the
carryback of a net operating loss is considered to have occurred on the
date the income tax return for the year in which the loss was incurred is
filed or due to be filed, whichever is the later. Therefore, no interest
accrues on the overpayment if refunded within 45 days of the date the
tax return for the loss year is filed.
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VI. Subject: Nonresidents and Part- Year Residents
( G. S. 105- 134.5( b)( c)( d))
1. Definition of Resident
G. S. 105 - 134.1( 12) defines a resident as “ an individual who is domiciled
in this State at any time during the taxable year or who resides in this
State during the taxable year for other than a temporary or transitory
purpose.”
Domicile is the place where an individual has a true, fixed permanent
home and principal establishment, and to which place, whenever he is
absent, he has the intention of returning. There are other definitions of
domicile, and this definition is presented solely to be used as a guide in
determining residency.
If an individual lives in North Carolina for more than 183 days of a tax
year, he is presumed to be a resident for income tax purposes in the
absence of factual proof to the contrary; but the absence of an individual
from the State for more than 183 days raises no presumption that he is
not a resident.
In many cases, a determination must be made as to when or whether
a domicile has been abandoned. A long standing principle in tax
administration, repeatedly upheld by the courts, is that an individual can
have but one domicile; and, once established, it is not legally abandoned
until a new one is established. A taxpayer may have several places of
abode in a year, but at no time can an individual have more than one
domicile. A mere intent or desire to make a change in domicile is not
enough; voluntary and positive action must be taken.
Listed below are some of the tests or factors to be considered in
determining the legal residence of an individual for income tax purposes.
Some factors are more important than others, and fulfilling a few does
not necessarily mean a change in domicile has occurred. As implied by
the list of factors below, an individual’s legal state of residence is reflected
more by the routine events of life rather than events such as voting or
obtaining a driver’s license which may occur every four or five years.
a. Place of birth of the taxpayer, the taxpayer’s spouse, and the
taxpayer’s children.
b. Permanent residence of the taxpayer’s parents.
c. Family connections and close friends.
d. Address used for federal tax returns, military purposes,
passports, driver’s license, vehicle registrations, insurance
policies, professional licenses or certificates, subscriptions for
newspapers, magazines, and other publications, and
monthly statements for credit cards, utilities, bank
accounts, loans, insurance, or any other bill or item that
requires a response.
e. Civic ties, such as church membership, club membership, or
lodge membership.
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f. Professional ties, such as licensure by a licensing agency or
membership in a business association.
g. Payment of state income taxes.
h. Place of employment or, if self - employed, place where
business is conducted.
i. Location of healthcare providers, such as doctors, dentists,
veterinarians, and pharmacists.
j. Voter registration and ballots cast, whether in person or by
absentee ballot.
k. Occasional visits or spending one’s leave “ at home” if a
member of the armed services.
l. Ownership of a home, insuring a home as a primary
residence, or deferring gain on the sale of a home as a
primary residence.
m. Location of pets.
n. Attendance of the taxpayer or the taxpayer’s children at State
supported colleges or universities on a basis of residence –
taking advantage of lower tuition fees.
o. Location of activities for everyday “ hometown” living, such as
grocery shopping, haircuts, video rentals, dry cleaning, fueling
vehicles, and automated banking transactions.
p. Utility usage, including electricity, gas, telecommunications,
and cable television.
Listed below are some of the events indicating when residency may
have changed:
1. Selling a house and buying a new one.
2. Directing U. S. Postal Service to forward mail to a new address.
3. Transferring family medical records to a new health care provider.
4. Notifying senders of statements, bills, subscriptions, and similar
items of new address.
5. Registering a vehicle in a new jurisdiction.
6. Transferring memberships for church, health club, lodge, or similar
activity.
7. Applying for professional certifications in a jurisdiction.
A legal resident of North Carolina serving in the United States Armed
Forces is liable for North Carolina income tax and North Carolina income
tax should be withheld from his military pay whether he is stationed in
this State or in some other state or country.
An individual who enters military service while a resident of North
Carolina is presumed to be a resident of this State for income tax purposes.
Residency in this State is not abandoned until a definite residence is
established elsewhere.
To change residency, the serviceman must not only be present in the
new location with the intention of making it his domicile, but must also
factually establish that he has done so.
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2. Nonresidents
The term “ nonresident” includes an individual:
a. Who resides in North Carolina for a temporary or transitory purpose
and is, in fact, a domiciliary resident of another state or
country; or
b. Who does not reside in North Carolina but has income from sources
within North Carolina and is, in fact, a domiciliary resident of
another state or country.
Under the Servicemembers Civil Relief Act, a member of the Armed
Services who is a legal resident of another state stationed in North
Carolina by virtue of military orders, is not subject to North Carolina
income tax on service pay but other income from employment, a business, or
tangible property in North Carolina is subject to North Carolina income
tax.
There is no presumption as to the residence of a spouse of a member
of the armed forces because of marriage. Legal residence will be
determined based on the facts in each case.
3. Part- Year Residents
An individual who moves his domicile ( legal residence) into or out of
North Carolina during the tax year, is a part - year resident.
4. Taxable Income of Nonresidents and Part- Year Residents
Nonresidents and part - year residents are required to prorate their
federal taxable income to determine the portion that is subject to North
Carolina tax.
The taxable income of a nonresident subject to North Carolina income
tax is determined by multiplying federal taxable income as calculated
under the Internal Revenue Code, as adjusted, by the percentage obtained
when dividing the portion of total federal gross income, as adjusted, derived
from North Carolina sources, by the total federal gross income, as adjusted.
The taxable income of a part - year resident subject to North Carolina
tax is determined by multiplying the total federal taxable income as
calculated under the Internal Revenue Code, as adjusted, by the
percentage obtained when dividing the portion of total federal gross income
received from all sources during the period the individual was a resident
of North Carolina, plus any gross income received from North Carolina
sources while a nonresident, by the total federal gross income, as adjusted.
An individual who files a joint federal income tax return but cannot
qualify to file a joint North Carolina income tax return because the
individual’s spouse is a nonresident and had no North Carolina taxable
income must calculate federal taxable income on a federal income tax
form as a married person filing a separate federal income tax return and
attach it to the North Carolina return to show how the separate federal
taxable income was determined. The separate federal return should reflect
only the individual’s income, exemptions, and deductions. In lieu of making
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the calculation on a federal form, an individual may submit a schedule
showing the computation of the separate federal taxable income. In this
case, the individual must attach a copy of the joint federal return unless
the federal return reflects a North Carolina address.
If an individual has income from sources within another state or country
while a resident of North Carolina and the other state or country taxes
the individual on such income, the individual may be eligible to claim a
tax credit on the North Carolina income tax return.
A nonresident is not entitled to the tax credit for tax paid to another
state or country.
5. Nonresident Members of Professional Athletic Teams
The North Carolina source income of a nonresident individual who is a
member of a professional athletic team is determined by multiplying the
individual’s total compensation for services rendered as a member of a
professional athletic team during the taxable year by a fraction, the
numerator of which is the number of duty days spent in North Carolina
rendering services for the team in any manner during the taxable year.
The denominator is the total number of duty days spent both within and
without North Carolina during the taxable year.
Travel days that do not involve either a game, practice, team meeting,
promotional caravan or other similar team event are not considered duty
days spent in North Carolina. However, such travel days are considered
duty days spent within and without North Carolina.
In determining the North Carolina source income of a nonresident
member of a professional athletic team, the following definitions apply:
a. The term “ professional athletic team” includes, but is not limited
to, any professional baseball, basketball, football, soccer or hockey
team.
b. The term “ member of a professional athletic team” includes those
employees who are active players, players on the disabled list and
any other persons required to travel and who do travel with and
perform services on behalf of a professional athletic team on a
regular basis. This includes, but is not limited to, coaches, managers
and trainers.
c. The term “ duty days” means all days during the taxable year from
the beginning of the professional athletic team’s official preseason
training period through the last game in which the team competes
or is scheduled to compete.
Duty days also include days on which a member of a professional
athletic team renders a service for a team on a date which does
not fall within the aforementioned period. Such services include
participation in instructional leagues, the “ Pro Bowl” or promotional
caravans. This includes days during the member’s off - season where
the member conducts training activities at the facilities of the team.
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Duty days include game days, practice days, days spent at team
meetings, promotional caravans and preseason training camps, and
days served with the team through all post - season games in which
the team competes or is scheduled to compete.
Duty days for any person who joins a team during the season
begins on the day the person joins the team, and for any person
who leaves a team ends on the day the person leaves the team.
Where a person switches teams during the taxable year, a separate
duty day calculation will be made for the period the person was
with each team.
Days for which a member of a professional athletic team is not
compensated and is not rendering services for the team in any
manner, including days when the person has been suspended
without pay and prohibited from performing any services for the
team, are not treated as duty days.
Days for which a player is on the disabled list are presumed not to
be duty days spent in North Carolina. However, such days are
considered to be included in total duty days spent within and without
North Carolina.
d. The term “ total compensation for services rendered as a member
of a professional athletic team” means the total compensation
received during the taxable year for services rendered:
( 1) from the beginning of the official preseason training period
through the last game in which the team competes or is
scheduled to compete during that taxable year; and
( 2) for an event during the taxable year which occurs on a date
which does not fall within the aforementioned period such
as participation in instructional leagues, the “ Pro Bowl” or
promotional “ caravans.”
Such compensation includes, but is not limited to, salaries, wages,
bonuses, and any other type of compensation paid during the taxable
year for services performed in that year. Such compensation does
not include strike benefits, severance pay, termination pay, contract
or option year buy - out payments, expansion or relocation payments,
or any other payments not related to services rendered to the
team.
e. “ Bonuses” are included in “ total compensation for services
rendered as a member of a professional athletic team” and subject
to allocation if they are:
( 1) earned as a result of play, such as performance bonuses,
during the season, including bonuses paid for championship,
playoff or “ bowl” games played by a team, or for selection
to all - star league or other honorary positions; and
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( 2) paid for signing a contract, unless all of the following
conditions are met:
a. the payment of the signing bonus is not conditional upon
the signee playing any games for the team, or performing
any subsequent services for the team, or even making the team;
b. the signing bonus is payable separately from the salary
and any other compensation; and
c. the signing bonus in nonrefundable.
Where the method for determining North Carolina source income does
not fairly and equitably apportion and allocate the compensation of a
nonresident member of a professional athletic team for services rendered
in North Carolina, the Secretary of Revenue may require the person to
apportion and allocate the compensation under another method prescribed
by the Secretary as long as the prescribed method results in a fair and
equitable apportionment and allocation. A nonresident member of a
professional athletic team may submit a proposal for an alternative method
to apportion and allocate the compensation, demonstrating that the method
provided under this section does not fairly and equitably apportion and
allocate the compensation. If approved, the proposed method must be
fully explained in the North Carolina income tax return filed by the
nonresident member.
See page 92 for the withholding requirements of professional athletic
teams.
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VII. Subject: S Corporations ( G. S. 105- 131 - G. S. 105- 131.8)
1. Reporting Income _ In General
An individual shareholder of an S corporation is required to take into
account his pro rata share of an S corporation’s net income in the manner
provided under Section 1366 of the Internal Revenue Code subject to
certain adjustments.
2. Resident Shareholders
Since 100 percent of the S corporation’s income is included in the
federal taxable income starting point, no adjustment because of doing
business outside of North Carolina is required by a resident.
3. Nonresident Shareholders
A nonresident shareholder of an S corporation takes into account only
his share of the S corporation’s income attributable to North Carolina in
the numerator of the fraction in determining that portion of federal taxable
income that is taxable to North Carolina. If an S corporation does business
in North Carolina and one or more other states, the income attributable
to North Carolina is determined by the same apportionment formula as
used for other corporations.
All nonresident shareholders must include an agreement with the first
S corporation return filed with North Carolina agreeing to be liable and
subject to the laws of North Carolina for individual income tax purposes;
otherwise, the S corporation becomes liable for the tax on the income
attributable to such nonresident shareholders at the rate for single
individuals.
A nonresident shareholder in an S corporation may claim the
proportionate share of the tax paid on his behalf by the S corporation to
North Carolina on his share of the S corporation income.
4. Tax Credits
If part of the S corporation’s income is earned within and taxed by
another state or country, either to the individual or to the corporation, a
resident shareholder is entitled to a tax credit on his individual income
tax return for his share of the tax paid to the other state or country. A
shareholder claiming the tax credit must attach a schedule to his income
tax return reflecting the total amount of tax paid to the other state or
country by the S corporation, and explaining how his pro rata share of
the tax was determined. A separate tax credit must be calculated for
each state or country to which the S corporation paid tax. Nonresident
shareholders are not allowed credit for tax paid to another state or country.
Pursuant to North Carolina General Statutes 105 - 134.6( a) and 105 -
130.5( a)( 10), an addition to federal taxable income is required on a
shareholder’s return for the amount of all tax credits claimed by the S
corporation and passed through to the individual shareholders, with the
exception of the credit for tax paid to another state or country and the
credit for donation of real property under G. S. 105 - 130.9( 4).
38
Example:
S corporation claims the tax credit for creating jobs ( G. S. 105 -
129.8). The installment for the tax year 2005 is $ 1,000 and the S
corporation elects to claim this credit against the income tax rather
than the franchise tax. There are two ( 50%) shareholders. Each
shareholder claims the jobs tax credit of $ 500 on his or her indi -
vidual income tax return. Therefore, each individual taxpayer must
add to federal taxable income the tax credit of $ 500 claimed on his
or her individual income tax return.
5. Basis in Stock
Due to different tax treatment of an S corporation’s income for State
and federal purposes for taxable years beginning before January 1, 1989,
a shareholder’s basis in the stock of an S corporation for State tax
purposes may be different than for federal tax purposes; thereby requiring
transitional adjustments in determining North Carolina taxable income
upon receipt by the shareholder of distributions from the S corporation
and upon disposition of the S corporation stock.
The initial basis of the stock in an S corporation to a nonresident of
North Carolina is zero, and the nonresident shareholder is not taxed on
distributions from the corporation and recognizes no income or loss upon
disposition of the stock. A nonresident shareholder’s basis in the S
corporation stock is adjusted for his pro rata share of the income or loss
of the corporation.
A resident shareholder’s initial basis in the stock of an S corporation is
determined as of the later of the date the stock is acquired, the effective
date of the S corporation election, or the date the shareholder became a
resident of North Carolina. A resident shareholder’s basis in the stock is
increased by his pro rata share of the corporation’s income adjusted
pursuant to G. S. 105 - 131.2 except for income exempt from federal or
State income taxes and deductions for depletion in excess of the basis of
the property being depleted. The basis is decreased by distributions to
the extent deemed a return of basis; a pro rata share of the losses of the
corporation as adjusted; nondeductible expenses of the corporation; and
the amount of the shareholder’s deduction for depletion of oil and gas
wells to the extent the deduction does not exceed the proportionate share
of the adjusted basis of that property allocated to the shareholder. The
adjustments to the basis do not apply to tax periods beginning prior to
January 1, 1989.
The aggregate amount of losses taken into account by the shareholder
of an S corporation may not exceed the combined adjusted basis of the
shareholder’s stock and indebtedness of the corporation to the shareholder.
Example:
A is a resident of North Carolina and his share of the loss of an S
corporation for the tax year 1989 is $ 50,000. On January 1, 1989,
A’s basis in the S corporation stock for federal income tax purposes
was $ 110,000, comprised of $ 40,000 initial cost plus his share of
39
the undistributed income of the S corporation of $ 70,000. Since
for federal tax purposes the loss does not exceed his basis, the
$ 50,000 is allowed as a deduction in computing federal taxable
income. For State tax purposes, his basis is the $ 40,000 initial cost
since the prior year undistributed income is not included in his
basis due to being for tax years prior to January 1, 1989. Therefore,
the loss that A may take into account in determining his North
Carolina taxable income is $ 40,000 and he is required to adjust federal
taxable income by $ 10,000 ($ 50,000 total loss less $ 40,000 basis).
6. Distributions
A resident shareholder must take into account distributions from an S
corporation in computing North Carolina taxable income to the extent
the distributions are characterized as dividends or as gains pursuant to
Section 1368 of the Internal Revenue Code. Section 1368 of the Code
provides that if the S corporation has no accumulated earnings and profits,
the amount distributed to a shareholder reduces the adjusted basis in his
stock. If the distribution exceeds his basis, the excess is treated as a
capital gain. If the S corporation has earnings and profits, the distribution
is applied in the following order:
( 1) To the Accumulated Adjustments Account ( AAA) which basically
includes the income during the period the corporation has been an
S corporation reduced by its losses and distributions during that
period. The AAA for State income tax purposes does not include
the federal AAA for tax years beginning prior to January 1, 1989.
The shareholder does not take into account distributions from the
AAA in determining taxable income but such distributions reduce
the adjusted basis of his stock.
( 2) To Earnings and Profits ( E and P): An S corporation is not
considered to have earnings and profits for State tax purposes for
years in which it operates as an S corporation after January 1,
1989. The E and P account basically includes the earnings and
profits on hand from the period the corporation was a C corporation;
and for State tax purposes, the E and P account also includes the
undistributed earnings and profits of the S corporation from tax
years beginning before January 1, 1989, ( the federal AAA that
existed on the day North Carolina began to measure the S
corporation shareholder’s income by reference to the income of
the S corporation). The amount distributed to the shareholder from
the E and P account is taxed to the shareholder as a dividend.
Since the State E and P account includes the federal AAA that
existed prior to the change in State law taxing the S corporation
income to the shareholders, federal taxable income must be
increased for any distributions from the federal AAA that existed
prior to the law change.
( 3) To the basis of the shareholder’s stock. Any excess over the
shareholder’s basis is taxed as a capital gain.
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A shareholder who makes an election for federal tax purposes to treat
distributions from the S corporation as being paid first from earnings and
profits may not make a different election for State purposes.
The following examples illustrate transitional adjustments required in
determining North Carolina taxable income of a shareholder from
distributions of S corporations:
( 1) A North Carolina corporation chartered on January 1, 1986, elected
to be taxed as an S corporation for federal income tax purposes.
Taxpayer A invested $ 100,000 in the corporation; and at the end
of the tax year 1988, A’s pro rata share of the S corporation’s
accumulated adjustments account for federal income tax purposes
was $ 50,000. A’s pro rata share of the S corporation’s net income
for the tax year 1989 was $ 20,000. The S corporation distributed
$ 100,000 to A during the tax year 1989. In this case, A would
include his $ 20,000 share of the S corporation’s net income in his
federal taxable income. For federal income tax purposes, A would
not be taxed on any part of the $ 100,000 distribution since it is
considered to have been paid from his accumulated adjustments
account and reduces the basis of his stock.
Original investment .................................................... $ 100,000
Accumulated adjustments account at the end of 1989
($ 50,000 plus $ 20,000) .......................................... 70,000
Adjusted basis of stock at end of year ...................... $ 170,000
Less: Distribution ....................................................... 100,000
Adjusted basis of stock as of January 1, 1990 .......... $ 70,000
For State income tax purposes, the $ 50,000 accumulated adjustments
account balance on December 31, 1988, is treated as additional earnings
and profits and A’s federal taxable income must be increased for any
part of the distribution attributable to earnings and profits in determining
North Carolina taxable income. The amount is determined as follows:
Investment in the corporation ................................... $ 100,000
Pro rata share of 1989 earnings —
accumulated adjustments account ......................... 20,000
Adjusted basis in stock at end of tax year ................ $ 120,000
Distributions .............................................. $ 100,000
Applied to accumulated adjustments
account .................................................. ( 20,000) ( 20,000)
Balance of distribution .............................. $ 80,000
Earnings and profits .................................. ( 50,000)
Balance of distribution .............................. $ 30,000 ( 30,000)
Basis in stock as of January 1, 1990 ........................ $ 70,000
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The $ 50,000 from earnings and profits is a transitional adjustment and
represents a dividend to the shareholder.
( 2) Shareholders of a North Carolina C corporation elect to be taxed
as an S corporation effective for the tax year beginning January 1,
1989. Taxpayer B, a resident of North Carolina, owned 4,000 shares
of the corporate stock with a basis of $ 500,000 at the time of the
election. At that time, B’s pro rata share of the C corporation’s
undistributed earnings and profits was $ 800,000. During the tax
year 1989, his pro rata share of the S corporation’s earnings was
$ 50,000 and the corporation distributed $ 1,000,000 to B in 1989. In
this case, B would include in federal taxable income his $ 50,000
pro rata share of the S corporation’s net income and dividends of
$ 800,000 representing his share of the undistributed earnings and
profits accumulated during the period the corporation operated as
a C corporation. His basis in the corporate stock for federal tax
purposes would be reduced to $ 350,000 determined as follows:
Cost of stock ............................................................. $ 500,000
1989 earnings — added to accumulated
adjustments account .............................................. 50,000
Basis before deductions ............................................ $ 550,000
Distributions ........................................ $ 1,000,000
Applied to accumulated adjustments
account ............................................ ( 50,000) ( 50,000)
Balance ............................................... $ 950,000
Applied to earnings and profits ........... ( 800,000)
Balance of distribution ........................ $ 150,000 ( 150,000)
Basis in stock as adjusted as
of January 1, 1990 ................................................. $ 350,000
No adjustment would be necessary in determining North Carolina
taxable income since the State and federal accumulated adjustment
account and the accumulated earnings and profit account are the same.
( 3) Shareholders of a North Carolina C corporation elected to be taxed
as an S corporation for federal income tax purposes effective
January 1, 1986. At that time, taxpayer X owned 200 shares of the
stock with a cost basis of $ 50,000. X’s pro rata share of the C
corporation’s undistributed earnings and profits on January 1, 1986,
was $ 20,000. His pro rata share of the earnings of the S corporation
was $ 10,000; $ 5,000; ($ 10,000); and $ 15,000, respectively, for the
tax years 1986, 1987, 1988 and 1989. No distributions were made
to X in the tax years 1986 and 1988. Distributions were made to X
of $ 10,000 in 1987 and $ 35,000 in 1989. In this case, X must include
his pro rata share of the 1989 earnings of $ 15,000 in his 1989
42
federal taxable income. The part of the $ 35,000 distribution that is
included in federal taxable income as a dividend is determined as
follows:
Distributions in 1989................................................... $ 35,000
Accumulated adjustments account —
1986 share of income ............................ $ 10,000
1987 share of income ............................ 5,000
1987 distribution ..................................... ( 10,000)
1988 share of income ( loss) ................... ( 10,000)
Balance as of 12/ 31/ 88 .......................... ( 5,000)
1989 share of income ............................ 15,000
Total ....................................................................... 10,000
Balance of distribution .............................................. $ 25,000
Applied to undistributed earnings while a
C corporation ( dividend) ........................................ 20,000
Excess distribution applied to reduce basis ............... $ 5,000
For federal tax purposes, X must include the $ 20,000 distribution of
earnings and profits in his federal taxable income as dividends. The
adjustment required in computing his North Carolina taxable income is
determined as follows:
Distributions in 1989.................................................. $ 35,000
Applied to accumulated adjustments account —
( 1989 share of income) .......................................... 15,000
Balance of distribution .............................................. $ 20,000
Undistributed earnings and profits:
Balance January 1, 1986 ........................... $ 20,000
Federal accumulated adjustments
account as of December 31, 1988 ......... ( 5,000)
Earnings and profits as adjusted
for State tax purposes ( treated
as dividend) ............................................ 15,000 ( 15,000)
Excess distribution applied to
reduce basis ........................................................... $ 5,000
X would be entitled to deduct $ 5,000 ($ 20,000 less $ 15,000) from his
federal taxable income as a transitional adjustment in computing his North
Carolina taxable income.
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7. Losses
The amount of loss a shareholder may deduct is limited to the adjusted
basis of the shareholder’s stock, plus the adjusted basis of any loans
owed to the shareholder by the corporation. The amount of the loss for
the taxable period is figured before the shareholder’s basis in the stock
is adjusted for any distributions during the tax year. If the amount of the
loss of a shareholder is limited because it exceeds the adjusted basis, the
excess is treated as incurred by the corporation in the next tax year.
8. Foreign S Corporations
North Carolina income tax is required to be withheld from compensation
paid to foreign S corporations for certain personal services performed in
North Carolina. ( See XVI. Withholding From Nonresidents for
Certain Personal Services.) If the S corporation has obtained a
certificate of authority from the Secretary of State, no tax is required to
be withheld if the S corporation provides to the payer the S corporation’s
corporate identification number issued by the Secretary of State.
S Corporations may claim credit on the S corporation franchise and
income tax return, Form CD - 401S, for the portion of the tax withheld
attributable to shareholders on whose behalf the corporation files a
composite return. The portion of the tax withheld attributable to
shareholders who are not part of a composite return must be allocated to
those shareholders on Schedule K of the S corporation return.
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VIII. Subject: Estates and Trusts ( G. S. 105- 160 - G. S. 105- 160.8)
1. General
All income of an estate or trust is taxed to the fiduciary or the beneficiary.
The conduit rules for taxing estates and trusts are applicable for North
Carolina income tax purposes. Under the conduit rules, regardless of
who is taxed, the income retains its same character as when received by
the estate or trust.
A trust is neither a resident nor a nonresident. A trust’s North Carolina
income tax liability is determined based, in part, on the situs of the income
beneficiaries, not where the trust was established or where the trustee
lives. North Carolina law requires the tax to be computed on the taxable
income of the estate or trust that is for the benefit of a resident of this
State, or for the benefit of a nonresident to the extent that the income ( 1)
is derived from North Carolina sources and is attributable to the ownership
of any interest in real or tangible personal property in this State or ( 2) is
derived from a business, trade, profession, or occupation carried on in
this State.
2. Estates and Trusts Returns
The federal taxable income of the fiduciary is the starting point for
preparing a North Carolina Income Tax Return for Estates and Trusts,
Form D - 407 and requires the same additions, deductions, and transitional
adjustments to federal taxable income as required for individuals.
The fiduciary responsible for administering the estate or trust is
responsible for filing the return and paying the tax. The fiduciary must
file an income tax return for the estate or trust for which he acts if he is
required to file a federal return for estates and trusts and ( 1) the estate
or trust derives income from North Carolina sources or ( 2) the estate or
trust derives any income which is for the benefit of a resident of North
Carolina. Exception: With respect to grantor trust returns, North
Carolina has access to the federal information contained in the federal
grantor trust returns. Therefore, a State grantor trust return is not required
to be filed when the entire trust is treated as a grantor trust for federal
tax purposes.
The return is required to be filed on or before April 15 if on a calendar
year basis and on or before the 15th day of the fourth month following
the end of the fiscal year if on a fiscal year basis. If the return cannot be
filed by the due date, the fiduciary may apply for an automatic six month
extension of time to file the return. To receive the extension, the fiduciary
must file Form D - 410P, Application for Extension for Filing Partnership,
Estate, or Trust Return, by the original due date of the return.
3. Payment of Tax
The tax rate for estates and trusts is the same as the tax rates for
single individuals. ( See the Tax Rate Schedule on page 5.)
The tax due on the estate and trust return is payable in full by the due
date of the return.
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4. Penalties
The penalty for failure to file an estate or trust return by the due date
is 5 percent of the tax per month with a minimum of $ 5.00 and a maximum
of 25 percent of the tax.
The penalty for failure to pay the tax by the due date is 10 percent of
the tax with a minimum penalty of $ 5.00.
Other penalties for fraud, negligence, and criminal penalties for willful
failure to comply with the income tax laws are similar to those applicable
to individuals.
5. Allocation of Adjustments
The additions and deductions to federal taxable income of an estate or
trust must be apportioned between the estate or trust and the beneficiaries
based on the distributions of income made during the taxable year. Unless
the trust instrument or will that created the estate or trust specifically
provides for the distribution of certain classes of income to different
beneficiaries, the apportionment of additions and deductions to the
beneficiaries is determined on the basis that each beneficiary’s share of
the income for regular tax purposes from Schedule K - 1, Federal Form
1041 relates to adjusted total income from Federal Form 1041. If the
trust instrument or will specifically provides for the distribution of certain
classes of income to different beneficiaries, any addition or deduction
directly attributable to a particular class of income must be apportioned
to the beneficiary to which that class of income is distributed. In allocating
the adjustments, for State purposes the amount of income for regular tax
purposes on Federal Schedule K - 1 must be adjusted for distributions to
the beneficiary which are not reflected in income for regular tax purposes.
The adjusted total income on Federal Form 1041 must be adjusted ( 1) to
exclude classes of income that are not part of the distribution to the
beneficiary; ( 2) to include classes of income that are a part of the
distribution to the beneficiary which are not included in adjusted total
income; and ( 3) by any deduction treated differently for State and federal
tax purposes that adjust federal taxable income pursuant to G. S. 105 -
134.6 and G. S. 105 - 134.7. After apportioning the additions and deductions
to the beneficiaries, the balance is apportioned to the fiduciary.
6. Allocation of Income Attributable to Nonresidents
If the estate or trust has income from sources outside of North Carolina
and if any of the beneficiaries are nonresidents of North Carolina, the
portion of federal taxable income of the fiduciary that is subject to North
Carolina tax must be determined. If there is no gross income from
dividends, interest, other intangibles or from sources outside North
Carolina for the benefit of a nonresident beneficiary, the total income of
the estate or trust is taxable to the fiduciary.
The determination of the amount of undistributed income from intangible
property which is for the benefit of a resident is based on the beneficiary’s
state of residence on the last day of the taxable year of the trust. In the
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case of both resident and nonresident beneficiaries, the determination of
the amount of undistributed income from intangible property which is for
the benefit of a resident is made on the basis that the resident beneficiary’s
interest for the taxable year relates to the interest of both resident and
nonresident income beneficiaries for the taxable year.
7. Tax Credits
Estates and trusts are allowed all tax credits allowed to individuals
except for:
a. Tax credit for income taxes paid by individuals to other states or
countries,
b. Tax credit for child and dependent care,
c. Tax credit for the disabled,
d. Tax credit for children, and
e. Tax credit for charitable contributions by nonitemizers
Form D - 407TC is used to report any tax credits claimed on an estate
or trust return. The amounts reflected on Form D - 407TC are the portions
of the tax credits allocated to the trust or estate. A fiduciary required to
pay an income tax to North Carolina for a trust for which he acts may
claim a credit for tax imposed and paid to another state or country on
income from sources within that state or country under the provisions of
G. S. 105 - 160.4( a).
A resident beneficiary of an estate or trust, the fiduciary of which
pays an income tax to another state or country on distributable income
reportable to North Carolina which is derived from sources in the other
state or country may claim a credit against his North Carolina income
tax for his share of tax paid the other state or country under the provisions
of G. S. 105 - 160.4( e).
Part 5 of Form D - 407TC is to be used in computing the tax credit
allowable to the estate or trust. Before this schedule may be completed
however, there must be an allocation between the estate or trust and its
beneficiaries of the tax paid and the gross income on which such tax
was paid to the other state or country.
The fiduciary’s share and each beneficiary’s share of the gross income
on which tax has been paid to another state or country is determined by
the governing instrument and should be entered in the appropriate schedule
on the return. The fiduciary’s share of total gross income to be used in
the tax credit computation schedule is the total gross income from Federal
Form 1041.
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IX. Subject: Partnerships ( G. S. 105- 154)
1. General
The partnership���s taxable income determined under the Internal
Revenue Code is the starting point for preparing the North Carolina
partnership income tax returns. The same additions, deductions, and
transitional adjustments to federal taxable income required for individuals
apply to partnerships.
2. Partnership Returns
A North Carolina partnership return ( Form D - 403), must be filed by
every partnership doing business in North Carolina if a federal partnership
return was required to be filed. The return of a partnership on a calendar
year basis is due on or before April 15 following the close of the calendar
year. If on a fiscal year basis, the return must be filed on or before the
15th day of the fourth month following the close of the fiscal year. If the
partnership return cannot be filed by the due date, the partnership may
apply for an automatic six month extension of time to file the return. To
receive the extension, the partnership must file Form D - 410P, Application
for Extension for Filing Partnership, Estate, or Trust Tax Return, by the
original due date of the return.
The return should include the names and addresses of the individuals
entitled to share in the net income of the partnership and should be signed
by the managing partner and the individual preparing the return. For
individual income tax purposes, the term “ business carried on in this
State” means the operation of any activity within North Carolina regularly,
continuously, and systematically for the purpose of income or profit. A
sporadic activity, a hobby, or an amusement diversion does not come
within the definition of a business operation in this State. Income from
an intangible source which is received in the course of a business operation
in this State so as to have a taxable situ